by Calculated Risk on 2/27/2007 06:24:00 PM

From the FDIC: FDIC Reports that Housing Slowdown Poses Challenge to Bank Loan Growth

The recent slowdown in residential construction could reduce the demand for mortgages and commercial real estate and construction loans -- activities that have been important factors in loan growth for banks and thrift institutions in recent years. That's according to the Winter 2006 edition of FDIC Outlook released today, which analyzes economic and banking conditions in each of the eight FDIC regions.

"While employment and income trends are positive in almost every region, the effects of the slowdown in residential construction activity are clearly visible," said FDIC Chairman Sheila C. Bair. "Going forward, insured banking institutions should pay careful attention to risk-management processes in this slower-growth environment."

Here is the conclusion from the San Francisco Region report:

Despite current strong economic and banking conditions in the West, increased reliance on historically volatile construction activity may stress local economies and the banking sector should the housing sector continue to weaken. An extended or sharp slowdown in construction activity could ripple through local economies and bank balance sheets and income statements. Although strength in other sectors—particularly the services sector—has emerged recently and could mitigate some of the negative effects of a slowing construction sector, elevated CRE and construction lending concentrations at FDIC-insured institutions will continue to be monitored closely for any signs of weakening in credit quality.

This is an understated warning. Especially concerning is the "elevated construction lending concentrations at FDIC-insured institutions". A CRE and C&D slump could exacerbate the economic problems caused by the housing sector slowdown.

Unfortunately nonresidential investment typically trails residential investment by three to five quarters. So it would not by unusual to see a CRE and C&D investment slump later this year with rising delinquency rates (See Investment Lags for an analysis of the lag times, as compared to residential investment, for equipment and software, and non-residential structures).

And here are the Commercial Bank Delinquency Rates released today by the Federal Reserve (through Q4 2006).

Click on graph for larger image.
Although commercial real estate delinquency rates are still historically low, they have started to move up. With the heavy concentration of CRE and C&D loans at FDIC institutions, a significant slump (like the early '90s) could pose a serious risk to these financial institutions.


As a review: this graph shows the YoY change in residential investment vs. nonresidential investment through Q4 2007. In general, residential investment leads nonresidential investment. There are periods when this observation doesn't hold - like '95 when residential investment fell and the growth of nonresidential investment remained strong - but it is reasonable, from a historical perspective, to expect a nonresidential investment slump in 2007.

by Calculated Risk on 2/27/2007 11:24:00 AM

"Some of these products that worked in the past don't work going forward," Chairman and Chief Executive Richard F. Syron, Freddie Mac 2/17/2007

From Freddie Mac: Freddie Mac Announces Tougher Subprime Lending Standards to Help Reduce the Risk of Future Borrower Default

Freddie Mac (NYSE: FRE) today announced that it will cease buying subprime mortgages that have a high likelihood of excessive payment shock and possible foreclosure. First, Freddie Mac will only buy subprime adjustable-rate mortgages (ARMs) – and mortgage-related securities backed by these subprime loans – that qualify borrowers at the fully-indexed and fully-amortizing rate. The goal is to protect future borrowers from the payment shock that could occur when their adjustable rate mortgages increase.

Second, the company will limit the use of low-documentation underwriting for these types of mortgages to help ensure that future borrowers have the income necessary to afford their homes. In addition, Freddie Mac will strongly recommend that mortgage lenders collect escrow accounts for borrowers’ taxes and insurance payments.

In keeping with its statutory responsibility to provide stability to the mortgage market, Freddie Mac will implement the new investment requirements for mortgages originated on or after September 1, 2007, to avoid market disruptions.
...
Freddie Mac’s new requirements cover what are commonly referred to as 2/28 and 3/27 hybrid ARMs, which currently comprise roughly three-quarters of the subprime market. Specifically, the company is requiring that borrowers applying for these products be underwritten at the fully- indexed and amortizing rate, as opposed to the initial "teaser" rate. The company also will limit the use of low-documentation products in combination with these loans. For example, the company will no longer purchase "No Income, No Asset" documentation loans and will limit "Stated Income, Stated Assets" products to borrowers whose incomes derive from hard-to-verify sources, such as the self-employed and those in the "cash economy." There will be a reasonableness standard for stated incomes.

In addition, Freddie Mac will require that loans be underwritten to include taxes and insurance and will strongly recommend that the subprime industry collect escrows for taxes and insurance, as is the norm in the prime sector. Because the maintenance of escrow accounts requires significant infrastructure and is not widely used in the subprime sector, Freddie Mac does not believe it is practical to unilaterally mandate it as a purchase requirement at this time.

by Calculated Risk on 2/27/2007 10:18:00 AM

The National Association of Realtors (NAR) reports: Existing-Home Sales Improve in January

Click on graph for larger image.

Total existing-home sales – including single-family, townhomes, condominiums and co-ops – increased 3.0 percent to a seasonally adjusted annual rate1 of 6.46 million units in January from an upwardly revised pace of 6.27 million in December. Sales were 4.3 percent below the 6.75 million-unit level in January 2006.

The above graph shows NSA monthly sales for 2005, 2006 and 2007. On an NSA basis, sales were 2.7% below January 2006.

Total housing inventory levels rose 2.9 percent at the end of January to 3.55 million existing homes available for sale, which represents a 6.6-month supply at the current sales pace – unchanged from the revised December level. Supplies peaked at 7.4 months in October.

Usually 6 to 8 months of inventory starts causing pricing problems, and over 8 months a significant problem. With current inventory levels at 6.6 months of supply, inventories are now well into the danger zone.

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

"Loose lending would be more correctly stated as no lending standards."
Jeff Lazerson, president of Mortgage Grader in Laguna Niguel, Feb 26, 2007

From the O.C. Register: Insider Q&A on home lending pitfalls

Q. Lets talk about loose underwriting standards. How big of an impact has loose lending had on home prices in Orange County?

A. "Loose lending would be more correctly stated as no lending standards. I would say that in Orange County and across the country prices have gone up, I would estimate 50 percent more than they should have, just because of no standards in underwriting and lending … Anyone could purchase a property as long as they could manipulate through the paperwork.”

I don't know if half of the recent price increases were due to "no lending standards", but I do agree that speculation, using non-traditional loans, played an important part in the price boom. I also agree with Lazerson on defaults:

"We haven’t seen anything yet with defaults. It’s going to get a lot worse before it gets better.”

by Calculated Risk on 2/26/2007 12:50:00 AM

From the WSJ: Home Lenders Cut the Flow Of Risky Loans

Fears about defaults are slowing the gusher of investor funds going to riskier segments of the mortgage market. That means less money available for "subprime" loans to riskier borrowers, forcing lenders to focus more on borrowers who can afford down payments and have well documented finances. With fewer lower-income Americans able to buy homes, downward pressure on prices will probably increase.

These pressures have intensified in recent days. The cost of insuring mortgage-bond holders against default risk, as measured by the so-called ABX index, has soared, deepening the concerns of investors in collateralized debt obligations, among the biggest holders of riskier mortgage bonds. Managers of some CDOs are delaying new offerings to "wait for the dust to settle," a process that could take weeks or months, says Chris Flanagan, head of CDO research at J.P. Morgan Chase & Co.

"CDO managers and hedge funds still want to do CDOs, but the conditions are much, much tougher," David Liu, a mortgage analyst with UBS AG, adds.

Interesting. And on the same topic, Fleck shares another email: Subprime housing game is over

"... today (last Wednesday) is the first day where equity managers have been in to us, asking questions about subprime. Until today, most of the equity managers knew something bad was happening in subprime, but were prepared to assume it was not going to be a problem for the wider credit market, the economy, and so on. ...

Slowly but surely, people are starting to get it, and slowly but surely, I am starting to think that the tipping point in credit -- via a subprime-generated shambles in CDO (collateralized debt obligation) land -- is closer than anybody imagines."

by Calculated Risk on 2/25/2007 11:30:00 PM

With the recent subprime mortgage news and the somewhat disappointing economic numbers, I've been looking to see if economists would start revising their forecasts for 2007.

Sure enough, the National Association for Business Economics (NABE) released their quarterly survey of 47 economists, from AP:

... forecasters now believe housing construction will plunge by 14.9 percent this year. That would be nearly three times bigger than the 5.5 percent fall in residential construction they had projected [for 2007] in the [November survey].

So once again these economists are "surprised" by housing.

And the impact on GDP?

The panel predicted that the overall economy will grow by 2.7 percent this year. ... NABE's November forecast put GDP growth this year at 2.5 percent.

So, three months later, these economists revised their forecasts down significantly for the housing market, and their GDP growth forecast up slightly. Uh, OK.

by Calculated Risk on 2/25/2007 12:46:00 PM

From U.S. News & World Report on Denver: A House Unsold, the Dream Dims

The ... result is ... [a] vicious cycle of "for sale" signs, foreclosures, then more "for sale" signs that is all but devastating Montbello. Bank-owned properties now represent more than 80 percent of all homes on the market there, putting even seemingly stable homeowners like Garcia up against a financial wall.

"I just can't take it anymore," he says of his street's overgrown yards, abandoned houses, and declining property values. "I put so much into this house and this community, but I don't have no equity."

With more than 2,500 square feet, new kitchen cabinets, tile, and a recently finished basement apartment, Garcia's house two years ago "would have gone for $210,000, maybe more," says David Cabrera, the real-estate agent whom Garcia hired last fall to sell the home, now priced at $195,500. "But nobody's buying now with all the foreclosures."

Garcia orginally paid $207,000 for this house four and a half years ago.

by Calculated Risk on 2/24/2007 01:02:00 AM

From CR: Every time Tanta posts on this blog, I receive a number of emails asking: Who is Tanta? Unfortunately her real identity is a state secret, but hopefully it is sufficient to say that Tanta is an experienced mortgage banker, and also an excellent and entertaining writer.

Holden Lewis recently mentioned Tanta at Bankrate.com:

Tanta ... has vast knowledge of the mortgage biz ... and is an excellent writer. ... if you're a mortgage loan officer or broker, o[r] if you're merely a homeowner who wants to understand the mortgage-servicing business, you must read Tanta's latest post, "Mortgage Servicing for Ubernerds."

Mr. Lewis also suggested that "a lot of this will be over your head", but I think you'll find that Tanta makes the inner workings of the mortgage business both interesting and understandable. So if you are interested in the mortgage business - and who isn't right now? - here are a few of Tanta's recent posts:

Tanta 2/20/2007: Mortgage Servicing for UberNerds

Tanta 1/31/2007 on "Scratch and Dent" Loans

Tanta 1/15/2007: Information is Power, Which is Why You Don’t Get Any

Tanta 12/21/2006: On Hybrids, Teasers, and Other Mortgage Guidance Problems

Tanta 12/15/2006: Let Slip the Dogs of Hell

Read, learn, and you'll probably laugh some too! All my best to Tanta.

by Calculated Risk on 2/23/2007 03:27:00 PM

From the San Diego Union: Lenders told foreclosure picture grim

Mortgage professionals who are struggling with a national spike in residential foreclosure rates were warned yesterday to expect more of the same in 2007.

Unemployment, mortgage fraud and speculative buying are among the factors behind the recent surge in filings, experts said at a conference of the Mortgage Bankers Association.

And this year $1 trillion in adjustable-rate mortgages are due to reset before Dec. 31.

“This is really a wild card,” said Rick Sharga of the Irvine firm RealtyTrac. “We don't have a precedent.”

Record inventories (see previous post) and rising foreclosures in 2007 is two of the keys to my 2007 housing predictions.

Mortgage attorney Daniel D. Phelan echoed Sharga's concerns.

“I personally think we are at the beginning of this cycle,” he said. “It is going to get worse before it gets better.”

The following graph shows Notices of Default (NOD) by year in California since 1992.

Click on graph for larger image.

Home mortgage loans in California went into default last quarter at the highest rate in more than eight years, according to the DataQuick Information Systems research firm. Lenders sent notices of default, the first step in the foreclosure process, to 37,273 California homeowners during the fourth quarter.

by Calculated Risk on 2/23/2007 12:28:00 PM

From the Chicago Tribune: Canceled contracts masked glut of homes, economist says

Housing analyst David Seiders told Chicago-area builders Thursday that the federal estimate of 3.5 million homes for sale at the end of 2006 is "grossly understated."

"There is a big inventory overhang out there, and it's bigger than anybody understands," he said.

In an annual forecast on the local industry in Addison, Seiders, chief economist of the National Association of Home Builders, cited the high level of sales contract cancellations in 2006. It created a snag in the recordkeeping, so many homes marked as sales in government data ended up back on the market too late to be counted as inventory, he said.

"Cancellation rates more than doubled between the end of 2005 and the end of 2006, meaning that net sales for the year nationally may be down 65 percent."

Caroline Baum reported on this issue last September: Think Housing's Stabilized? See Cancellations

Of course Seiders thinks the bottom is near:

But Seiders was not all gloom, saying the market is probably at the year's low spot right now. He expects slight improvement at midyear.