by Calculated Risk on 3/05/2007 10:36:00 AM

Bloomberg reports: U.S. ISM Services Index Falls More Than Forecast

Service industries in the U.S. expanded at the slowest pace almost four years last month, suggesting the housing slump may be filtering through to other parts of the economy.
...
``The downtrend in home prices threatens consumer borrowing and consumer spending as a whole,'' Avery Shenfeld, a senior economist at CIBC World Markets Inc. in Toronto, said before the report. ``People recognize now that housing is not yet stabilizing.''

Service industries are still expanding, but the pace has slowed. And yes, Wall Street housing forecasts are "no longer operative"!

by Calculated Risk on 3/04/2007 06:07:00 PM

As an excuse for more discussion in the comments, here are the areas I suggested watching at the beginning of the year:

1) A credit crunch based on bad loans in the RE sector leading to another down turn in the housing market (and possibly in CRE and C&D too, later in the year),

2) the loss of several hundred thousand residential construction jobs,

3) less consumer spending based on falling MEW.

Here is my estimate of the impact of the subprime implosion on existing home sales.

After the first two months of 2007, most Wall Street housing forecasts are already - in the words of Nixon press secretary Ron Zeigler - "No longer operative."

by Calculated Risk on 3/03/2007 06:33:00 PM

Looking forward to the employment report next Friday, I'm expecting to see a significant decline in residential construction employment.

Click on graph for larger image.

This graph shows starts, completions and residential construction employment. (starts are shifted 6 months into the future). Completions and residential construction employment are highly correlated, and Completions lag Starts by about 6 months.

Based on historical correlations, it is reasonable to expect Completions and residential construction employment to follow Starts "off the cliff". This would indicate the loss of 400K to 600K residential construction employment jobs by this Summer.

Dr. Asha Bangalore suggests we also look at the YoY change in nonfarm employment.

The YoY change in employment has already started to decline, and will probably decline more during the coming months. This could be a mid-cycle slowdown, as happened in the mid-'80s and mid-'90s, or it could be the prelude to a recession. Employment is generally considered a coincident indicator for the economy, so for now the focus will be on residential construction and retail employment.

The housing bust started in San Diego before most other markets. So it is interesting to see what is happening to the job market in San Diego (hat tip: Mozo Maz) from the San Diego Union: County unemployment hits a six-month high

... significant were the cuts in the real estate industry, continuing a five-month decline. January's job cutbacks included 2,500 construction workers, 700 real estate workers and 1,100 workers at furniture and home-improvement stores.

“The housing sector is really starting to have an impact on our overall year-to-year job numbers,” said Alan Gin, economist at the University of San Diego.

Gin worried that the real estate downturn is affecting the retail market. From January 2005 to January 2006, 2,500 retail workers lost their jobs, mostly in department stores.

“When you've got fewer people working in construction and fewer people buying homes, you've got fewer people shopping in the community, and that can translate to fewer retail jobs,” Gin said.
...
Howard Roth, chief economist for the California Department of Finance, ... said the slowdown is having an impact on the state's income tax revenue.

In January, the state took in about $8 billion in income taxes – $1 billion less than previously forecast. Roth said that part of the drop was due to declines in the money earned by real estate brokers and professionals in related industries.

The report next Friday should be interesting.

by Calculated Risk on 3/03/2007 04:50:00 PM

"We're all going to be struggling, struggling more than we are today. We're headed halfway down the mountain, and we've got a ways to go."
Robert A. Camerota, Sr., GMAC Mortgage Group senior vice president, March 3, 2007

From North County Times: Prominent mortgage exec sees further dip in market

by Calculated Risk on 3/03/2007 01:18:00 PM

Floyd Norris writes in the NY Times: When It Comes to House Prices, the Bloom Is Off the Cactus

The [Standard & Poor’s/Case-Shiller home price] indexes, which now cover 20 regions, ... [record] all sales in an area, and then [compare] the price with the price that house fetched the last time it changed hands. They include only single-family homes, not condominiums or cooperative apartments, which can distort the picture in areas where such apartments form a major part of the housing market.

Click on graph for 12 areas.

The graphic shows the performance of the indexes, year over year, for 12 areas. They illustrate the wide regional variances, showing that Phoenix was not the only part of the desert that boomed. Las Vegas, with a 53 percent year-over-year rise in the fall of 2004, set the mark for best annual performance. In 2006, prices there rose just 0.9 percent.

Big coastal markets also did very well, although not to that extreme, and are now coming down. Prices in the New York region slipped just a bit in 2006, although that figure is distorted because it ignores Manhattan apartment prices, which have been strong. Larger declines were recorded in Boston, Washington, San Francisco and San Diego, but Los Angeles eked out a 2 percent rise for the year.

by Calculated Risk on 3/02/2007 09:11:00 PM

New Century Financial filed their "Notification of Late Filing" today with the SEC. A few excerpts:

To date, six of the Company’s 11 financing arrangements whose agreements contain this rolling two-quarter net income covenant have executed waivers. Certain of these waivers will become effective when the Company receives similar waivers from each of the other lenders having the rolling two-quarter net income covenant.
...
In the event the Company is unable to obtain satisfactory amendments to and/or waivers of the covenants in its financing arrangements from a sufficient number of its lenders, or obtain alternative funding sources, KPMG has informed the Audit Committee that its report on the Company’s financial statements will include an explanatory paragraph indicating that substantial doubt exists as to the Company’s ability to continue as a going concern.

And on the criminal probe:

On February 28, 2007, the Company received a letter from the United States Attorney’s Office for the Central District of California (the “U.S Attorney’s Office”) indicating that it was conducting a criminal inquiry under the federal securities laws in connection with trading in the Company’s securities, as well as accounting errors regarding the Company’s allowance for repurchase losses. The U.S. Attorney’s Office is requesting voluntary assistance by the Company, which the Company has agreed to provide.

by Calculated Risk on 3/02/2007 05:34:00 PM

From the Fremont SEC filing:

Fremont General Corporation (the "Company") could not file its Annual Report on Form 10-K for the fiscal year ended December 31, 2006 by March 1, 2007 without unreasonable effort or expense for the reasons set forth below.

In light of the current operating environment for subprime mortgage lenders and recent legislative and regulatory events, Fremont Investment & Loan, the Company's wholly owned industrial bank subsidiary ("FIL"), intends to exit its subprime residential real estate lending business. Management and the board of directors are engaged in discussions with various parties regarding the sale of the business.

Additionally, the Company expects that it, FIL and the Company's wholly owned subsidiary, Fremont General Credit Corporation ("FGCC"), will enter into a voluntary formal agreement, to be designated as a cease and desist order (the "Order"), with the Federal Deposit Insurance Corporation (the "FDIC"). Among other things, the Order will require FIL to cease and desist from the following:

o Operating with management whose policies and practices are detrimental to FIL;

o Operating FIL without effective risk management policies and procedures in place in relation to FIL's brokered subprime mortgage lending and commercial real estate construction lending businesses;

o Operating with inadequate underwriting criteria and excessive risk in relation to the kind and quality of assets held by FIL;

o Operating without an accurate, rigorous and properly documented methodology concerning its allowance for loan and lease losses;

o Operating with a large volume of poor quality loans;

o Engaging in unsatisfactory lending practices;

o Operating without an adequate strategic plan in relation to the volatility of FIL's business lines and the kind and quality of assets held by FIL;

o Operating with inadequate capital in relation to the kind and quality of assets held by FIL;

o Operating in such a manner as to produce low and unsustainable earnings;

o Operating with inadequate provisions for liquidity in relation to the volatility of FIL's business lines and the kind and quality of assets held by FIL;

o Marketing and extending adjustable-rate mortgage ("ARM") products to subprime borrowers in an unsafe and unsound manner that greatly increases the risk that borrowers will default on the loans or otherwise cause losses to FIL, including (1) ARM products that qualify borrowers for loans with low initial payments based on an introductory rate that will expire after an initial period, without adequate analysis of the borrower's ability to repay at the fully indexed rate, (2) ARM products containing features likely to require frequent refinancing to maintain affordable monthly payment or to avoid foreclosure, and (3) loans or loan arrangements with loan-to-value ratios approaching or exceeding 100 percent of the value of the collateral;

o Making mortgage loans without adequately considering the borrower's ability to repay the mortgage according to its terms;

o Operating in violation of Section 23B of the Federal Reserve Act, in that FIL engaged in transactions with its affiliates on terms and under circumstances that in good faith would not be offered to, or would not apply to, nonaffiliated companies; and

o Operating inconsistently with the FDIC's Interagency Advisory on Mortgage Banking and Interagency Expanded Guidance for Subprime Lending Programs.

The Order will also require FIL to take a number of steps, including (1) having and retaining qualified management; (2) limiting the Company's and FGCC's representation on FIL's board of directors and requiring that independent directors comprise a majority of FIL's board of directors; (3) revising and implementing written lending policies to provide effective guidance and control over FIL's residential lending function; (4) revising and implementing policies governing communications with consumers to ensure that borrowers are provided with sufficient information; (5) implementing control systems to monitor whether FIL's actual practices are consistent with its policies and procedures; (6) implementing a third-party mortgage broker monitoring program and plan; (7) developing a five-year strategic plan, including policies and procedures for diversifying FIL's loan portfolio; (8) implementing a policy covering FIL's capital analysis on subprime residential loans; (9) performing quarterly valuations and cash flow analyses on FIL's residual interests and mortgage servicing rights from its residential lending operation, and obtaining annual independent valuations of such interests and rights; (10) limiting extensions of credit to certain commercial real estate borrowers; (11) implementing a written lending and collection policy to provide effective guidance and control over FIL's commercial real estate lending function, including a planned material reduction in the volume of funded and unfunded nonrecourse lending and loans for condominium conversion and construction as a percentage of Tier I capital; (12) submitting a capital plan that will include a Tier I capital ratio of not less than 14% of FIL's total assets; (13) implementing a written profit plan; (14) limiting the payment of cash dividends by FIL without the prior written consent of the FDIC and the Commissioner of the California Department of Financial Institutions; (15) implementing a written liquidity and funds management policy to provide effective guidance and control over FIL's liquidity position and needs; (16) prohibiting the receipt, renewal or rollover of brokered deposit accounts without obtaining a Brokered Deposit Waiver approved by the FDIC; (17) reducing adversely classified assets; and (18) implementing a comprehensive plan for the methodology for determining the adequacy of the allowance for loan and lease losses.

In addition, the Company is analyzing, in connection with the preparation of the Company's consolidated financial statements as of and for the period ended December 31, 2006, the FDIC's criticism with respect to the Company's methodology for determining the carrying value of the Company's residential real estate loans held for sale.
...
In addition, the Company is analyzing, in connection with the preparation of the Company's consolidated financial statements as of and for the period ended December 31, 2006, the FDIC's criticism with respect to the Company's methodology for determining the carrying value of the Company's residential real estate loans held for sale.

The Company will report a net loss from continuing operations for the fourth quarter of 2006 as compared to net income of $54.5 million for the fourth quarter of 2005. The net loss to be reported for the fourth quarter of 2006 will be due in part to increased provisions for loan repurchase and repricing, valuation and premium recapture reserves. In light of the Company's reported operating results for the nine months ended September 30, 2006, and the fact that the Company will report a net loss for the fourth quarter of 2006, the Company's operating results for the fiscal year ended December 31, 2006 will represent a significant change from the Company's operating results for the fiscal year ended December 31, 2005.

The Company is unable to estimate its results of operations for the fourth quarter of 2006 and full-year 2006 until it completes its review of its methodology for determining the carrying value of its held-for-sale residential real estate loan portfolio, as discussed above.

by Calculated Risk on 3/02/2007 02:06:00 PM

From MarketWatch: Bond default protection shoots up for banks

The cost of insurance against a default by top investment banks Goldman Sachs Group Inc., Merrill Lynch & Co Inc, Lehman Brothers Holdings Inc and Morgan Stanley ballooned this week, amid increased nervousness about their exposure to the shaky subprime lending market.

The trend toward more expensive credit-default swap protection for these four banks began last week and accelerated this week, said Michael Fuhrman, an institutional equities salesman for GFI, an inter-dealer broker for credit derivatives.
...
On Friday credit default swaps for Goldman Sachs, the world's biggest securities firm, grew to $33,000 per $10 million in credit protection instruments, up from $26,000 per $10 million on Monday, according to GFI data.

Merrill Lynch CDS cost $25,000 per $10 million in instruments on Monday and grew to $33,000 per $10 million at the end of the week; Lehman CDS protection rose from $28,000 per $10 million in instruments to $35,000 per $10 million and Morgan Stanley CDS protection rose from $27,000 per $10 million to $33,000 per $10 million in the last five days, GFI said.

And from Bloomberg (hat tip: Brian): Goldman, Merrill Almost `Junk,' Their Own Traders Say

Goldman Sachs Group Inc., Merrill Lynch & Co. and Morgan Stanley, which earned a record $24.5 billion in 2006, suddenly have become so speculative that their own traders are valuing the three biggest securities firms as barely more creditworthy than junk bonds.

Prices for credit-default swaps linked to the bonds of the New York investment banks this week traded at levels that equate to debt ratings of Baa2, according to Moody's Investors Service. For Goldman, Morgan Stanley and Merrill that's five levels below the actual Aa3 rating on their senior unsecured notes and two steps above non-investment grade, or junk.

by Calculated Risk on 3/02/2007 12:51:00 PM

UPDATE: Added Tanta's comments (see bottom).

From the Fed: Agencies Seek Comment on Subprime Mortgage Lending Statement

The federal financial regulatory agencies today issued for comment a proposed Statement on Subprime Mortgage Lending to address certain risks and emerging issues relating to subprime1 mortgage lending practices, specifically, particular adjustable-rate mortgage (ARM) lending products.

The proposal addresses concerns that subprime borrowers may not fully understand the risks and consequences of obtaining these products, and that the products may pose an elevated credit risk to financial institutions. In particular, the proposed guidance focuses on loans that involve repayment terms that exceed the borrower’s ability to service the debt without refinancing or selling the property.

The statement specifies that an institution’s analysis of a borrower’s repayment capacity should include an evaluation of the borrower’s ability to repay the debt by its final maturity at the fully indexed rate, assuming a fully amortizing repayment schedule. The statement also underscores that communications with consumers should provide clear and balanced information about the relative benefits and risks of the products. If adopted, this statement would complement the 2006 Interagency Guidance on Nontraditional Mortgage Product Risks, which did not specifically address the risks of these ARM products.

The agencies request comment on all aspects of the proposed statement and are particularly interested in public comment about whether: 1) these arrangements always present inappropriate risks to institutions and consumers, or the extent to which they can be appropriate under some circumstances; 2) the proposed statement would unduly restrict existing subprime borrowers’ ability to refinance their loans; 3) other forms of credit are available that would not present the risk of payment shock; 4) the principles of the proposed statement should be applied beyond the subprime ARM market; and 5) an institution’s limiting of prepayment penalties to the initial fixed-rate period would assist consumers by providing them sufficient time to assess and act on their mortgage needs.

Comments are due sixty days after publication in the Federal Register, which is expected shortly. The guidance is attached.

From Tanta in the comments:

On page seven, under the definition of “predatory lending,” you find:

“Making mortgage loans based predominantly on the foreclosure or liquidation value of a borrower’s collateral rather than on the borrower’s ability to repay the mortgage according to its terms.”

Now, they’ve been using this kind of language for years; it’s not like this is new to this document. The problem is that, for years, some of us have wanted them to go on to the next logical step, which is to explain just how a loan can be based on the borrower’s ability to repay if it doesn’t include verification of income and assets. What we have found over the years here, you know, is that lenders have come to think that they can just verify the borrower’s willingness to repay, which is what a FICO score and a down payment proxy, but not the ability to repay out of either income or assets. So they keep using that word “ability,” and then they keep going on as follows:

“Risk-layering features in a subprime mortgage loan may significantly increase the risks to both the institution and the borrower. Therefore, an institution should have clear policies governing the use of risk-layering features, such as reduced documentation loans . . . an institution should demonstrate the existence of effective mitigating factors that support the underwriting decision and the borrower’s repayment capacity.”

OK, so which is it? Is the absence of documentation of “ability to repay” mitigated by the appraised value and the FICO score? How is that, exactly, different from making a loan based on collateral value?

“The higher a loan’s risk, either from loan features or borrower characteristics, the more important it is to verify the borrower’s income, assets, and liabilities. When underwriting higher risk loans, stated income and reduced documentation should be accepted only if there are mitigating factors that clearly minimize the need for direct verification of repayment capacity. For many borrowers, institutions should be able to readily document income using recent W-2 statements, pay stubs or tax returns. A higher interest rate is not considered an acceptable mitigating factor.”

I put that last sentence in bold because it is the only outright statement of something you could call an actual rule in this document. But notice how they’re still waffling about the issue of collecting those W-2s, pay stubs, and tax returns. Look, any underwriter worth her salt will tell you that there are, in fact, good credit risk borrowers out there whose income cannot be easily read off one of those documents. The classic self-employed borrower with odd cash-flow patterns comes to mind. But there’s just a world of difference between telling a bank it can, if it finds mitigating factors, override the numbers on the documents, and telling the institution that it can get away with not asking to see them. The whole “stated income” thing gets to be a problem because the industry decided there were only two choices: use the numbers on the tax returns—even if they don’t make much sense as a measure of GMI, and resulted in terrible-looking DTIs—or just let the borrower make things up.

There are two very, very important issues underlying this false dichotomy. One, we’ve seen in action lately, and you can call it the “rep and warranty” problem. If I see your tax returns, but approve you anyway because I did an operating income analysis, looked at the value of your assets, and decided that you should get a loan even though technically your DTI calculates too high, then it is the quality of my underwriting decision that is at stake here. If, however, I tell the LO to throw those tax returns away and resubmit the file as “stated,” then I still get to make the loan, but if it turns out to be a bad idea after all, I can claim to have been defrauded by the borrower. It remains a major mystery why the regulators haven’t caught on to this yet.

Two, there is actually some research out there on the question of “lender-chosen” versus “borrower-chosen” documentation reductions. Moody’s, for instance, has found that programs in which the lender expects documentation from all borrowers, but, after analysis of the application, credit report/FICO, and any other supporting documentation, may waive the income or asset documentation requirement for higher-quality borrowers, perform much better than programs in which the borrower can withhold documentation from the lender and get qualified on a presumption of reduced documentation. Fannie Mae and Freddie Mac, for instance, do this with their automated underwriting systems: the originator enters the application data into the system, which automatically provides itself with a credit report and (usually) data about the property and plausibility of the sales price/appraised value (an internal AVM). It then evaluates the loan, and if it likes what it sees enough, it may report back to the originator that, say, the loan can be counted as “full doc” with just the last pay stub (no W-2s for the last two years), or with just one bank statement showing enough funds to close (instead of three months worth of bank statements showing funds to close plus reserves). The point here is that the borrower doesn’t get to walk in the door and say, “I want one of those loans where I don’t have to give you my W-2 or my bank statements.” That latter thing would be the “borrower-chosen” approach, and those are the ones that perform really poorly. Of course, a “lender-chosen” program will also perform really poorly if the underwriting analysis gives too much weight to DTI or down payment in the initial analysis. (That is, if you’re hanging your hat on DTI, it’s not wise to waive the documentation of the income. If you’re hanging your hat on down payment, it’s not wise to waive the documentation of the source of those funds. You have to do a demonstrated holistic approach in order to do a “lender-chosen” program correctly.)

I honestly can’t see any reason why the regulators wouldn’t at the very minimum require that institutions making reduced doc subprime loans handle this the way the GSEs do, namely only as lender-chosen, not as borrower-chosen, programs which require documentation for most borrowers and waive documents only after a holistic review. But they don’t even raise the issue in the guidance. What’s with that?

Tanta

by Calculated Risk on 3/01/2007 10:45:00 PM

Press Release: New Century Financial Corporation to File Form 12b-25 With the SEC

New Century Financial Corporation (NYSE: NEW - News), a mortgage real estate investment trust (REIT), today announced that it expects to file a Form 12b-25 with the Securities and Exchange Commission (SEC) with respect to its Annual Report on Form 10-K for the fiscal year ended December 31, 2006. The Form 12b-25 will be filed with the SEC on March 2, 2007.