by Calculated Risk on 7/12/2007 08:55:00 AM

From Bloomberg: U.S. Foreclosures Jump 87 Percent as Lending Practices Tighten

There were 164,644 loan default notices, scheduled auctions and bank repossessions in June, led by filings in California, Florida, Ohio and Michigan that together accounted for half the total, according to RealtyTrac, a seller of foreclosure data.

The June foreclosure figure was 7 percent lower than that in May, when filings reached a 30-month high ...
...
An estimated 58 percent of properties in the foreclosure process are linked to borrowers with subprime loans, and RealtyTrac expects U.S. foreclosures to reach 1.8 million by year's end ...

by Calculated Risk on 7/11/2007 10:04:00 PM

On Bloomberg Video: (hat tip Miguela)


Click image for video.

Ohio Attorney General Marc Dann talks with Bloomberg's Brian Sullivan from Columbus about the Ohio's investigation of credit-rating agencies and mortgage brokers, the state's anti-predatory lending statute, and the relationship between credit-rating agencies and investment banks. (Source: Bloomberg)

Note: If clicking the picture doesn't work, try here.

by Calculated Risk on 7/11/2007 08:59:00 PM

Note: I changed the post title. Orginally I quoted the WSJ blurb that Moody's had cut the ratings, but that appears to be premature. The WSJ blurb:

"Moody's cut its rating on some $5 billion in CDOs, a sign of the subprime market's impact on other investments."

Orginal post: From the WSJ: CDOs Are Hit With Fallout From Laxity With Subprimes

Turmoil in the subprime-mortgage market fanned out yesterday, hitting a group of investments that are exposed to this struggling class of home loans.

Moody's Investors Service said yesterday it may cut its credit ratings on slices of 91 collateralized-debt obligations, or about $5 billion of securities. It is a small percentage of the overall CDO market, but still an important development, because it is a signal that subprime fallout is rippling through financial markets to an important class of investments.

In another sign of these ripple effects, Fitch Ratings released a report yesterday raising cautionary flags about the commercial real-estate market. It projected rising defaults in this sector after years of increasingly lax lending standards, which could hit bonds backed by commercial real-estate loans.

UPDATE: Financial Times: Investors’ flight from risk picks up pace

Investors in European and US credit markets accelerated their flight from risk on Wednesday as the turmoil from the US mortgage markets continued to spill over into other asset classes.

The change in sentiment, which triggered sharp moves in credit derivatives markets, suggested that recent problems in the subprime mortgage sector could be spreading to other corners of the financial world.
...
JPMorgan observed that swings in derivatives prices were so extreme they implied “scenarios in which the core of the global liquidity system suffers a serious assault”. But it stressed “the meltdown in the credit indices seem completely at odds” with trends in the real economy, implying it should be reversed.

by Calculated Risk on 7/11/2007 05:47:00 PM

Many of us have been trying to understand why BLS reported residential construction employment has only fallen 4% from the peak (March 2006), even though housing completions have fallen close to 30%.

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 were highly correlated, and Completions used to lag Starts by about 6 months.

Both of these relationships have broken down somewhat (although completions have fallen to the level of starts). The time between start and completion has increased recently. But the puzzle is why residential construction employment hasn't fallen further.

The main explanations have been:
1) The BLS has not counted illegal immigrants working in construction.
2) The BLS Birth/Death model has missed the turning point in employment, and therefore the BLS has overstated the current number of residential construction employees.
3) Some construction employees have moved from residential to commercial work, but they are still being reported as residential construction employees to the BLS.
4) Some companies are "hoarding" workers for the expected recovery.
5) Many workers are still employed, but they are working far fewer hours.

Yesterday, Greg Ip at the WSJ reviewed an analysis from Deutsche Bank economists suggesting that the illegal immigrant explanation accounts for most of the misssing job losses.

In a new report, economists at Deutsche Bank estimate construction employment should have fallen about 900,000 since early 2006 when in fact it’s only down 150,000. They conclude 500,000 of the unexplained gap is attributable to layoffs of illegal Hispanic workers.

The economists addressed most of the other explanations listed above:

Deutsche Bank dispute many competing explanations for the disconnect between home building and construction employment. Errors in the Bureau of Labor Statistics’ “birth/death” model, which estimates job creation and destruction at new firms, can only account for 20,000 construction jobs, they say. It’s unlikely many workers now classified as employed in residential construction have moved to commercial work because the type of work is so different, they say. Third, the notion that because of lags, the layoffs have yet to come, is “starting to wear thin ... We are now 1.5 years into the slowdown .... We find ourselves increasingly skeptical with the notion that construction companies have not yet recognized the severity of the situation.”

Although uncounted illegal immigrant workers might account for some of the puzzle, this analysis is not very satisfying.

I'm not sure why the Deutsche Bank economists think errors in the birth/death model can only account for 20,000 construction jobs. We know from the Business Employment Dynamics Summary that 77,000 construction jobs (NSA) were lost in Q3 2006, and yet the BLS reported a gain of 5,000 construction job (NSA) for the quarter. That is a difference of 82,000 jobs (1) (NSA) and we don't know the errors for Q4 2006, and Q1 2007 yet.

This brings us to a second potential flaw in their analysis. The economists wrote:

the notion that because of lags, the layoffs have yet to come, is “starting to wear thin ... We are now 1.5 years into the slowdown ..."

Actually employment tracks completions, not starts - and completions only fell off the cliff starting at the beginning of 2007. It is very possible that many workers are still employed - for now - but are working reduced hours. This would be combination of explanations 4 and 5 above.

And if the BLS missed by 82,000 workers (NSA) in Q3 2006 before completions started falling off a cliff, perhaps they missed by many more in Q1 and Q2 2007 when completions were dropping rapidly.

And finally, I believe there is some merit to the argument that workers have moved from residential to commercial work, and are still being reported as residential workers to the BLS. Commercial construction spending has increased 25% from January 2006 to May 2007, but the number of workers in non-residential construction has only increased 4% over the same time period. This raises the opposite question: why hasn't the boom in commercial construction created more jobs?

I think the answer will be combination of these explanations.

(1) Note: In a previous post, I used SA instead of NSA numbers and overestimated the BLS error.

by Calculated Risk on 7/11/2007 01:49:00 PM

From Reuters: U.S. FDIC chief looking at banks' CDO exposure (hat tip dotcommunist)

The Federal Deposit Insurance Corp. is looking "very carefully" at banks' exposure to collateralized debt obligations (CDOs) tied to subprime mortgages and whether rising default rates may creep into higher-rated CDO tranches.

"We're going to see more downgrades," FDIC Chairman Sheila Bair said on Wednesday, referring to a slew of CDO downgrades announced on Tuesday by two major credit rating agencies.
...
"I think the question is, to what extent is this going to creep into the higher-rated tranches. Most of these securitizations are over-collateralized but giving rising default rates and the fact that a lot of these loans haven't reset yet, it could creep into the higher-rated tranches," Bair said after addressing a Washington meeting of the New York Bankers Association.

"We're certainly looking at CDO exposures (of banks) very carefully and monitoring whether they could creep into higher-rated tranches," Bair said.

Did someone forget to send Bair the "contained" talking point memo?

by Calculated Risk on 7/11/2007 12:35:00 PM

Another month, another downward revision to the NAR forecast for 2007:

Feb 7, 2007: Existing-Home Sales To Improve, With Later Recovery For New Homes

Existing-home sales ... are forecast at 6.44 million in 2007

April 11, 2007: Tighter Lending Standards Good For Housing, But Will Dampen Sales

Existing-home sales are likely to total 6.34 million in 2007

May 9, 2007: Housing Forecast Changed Slightly Due to Impact From Tighter Lending

Existing-home sales are likely to total 6.29 million this year

June 6, 2007: Home Sales Projected to Fluctuate Narrowly With a Gradual Upturn

Existing-home sales are projected to total 6.18 million in 2007

July 11, 2007: Home Prices Expected to Recover in 2008 As Inventories Decline

Existing-home sales are expected to total 6.11 million this year

The NAR forecasts are too optimistic, and the headlines are hilarious too (see Nutting's comment on the current headline below). My forecast is still for 5.6 to 5.8 million existing home sales in 2007.

Rex Nutting at MarketWatch on the current NAR forecast: Single-family starts to fall again in 2008: Realtors

Construction of single-family homes will probably decline for a third straight year in 2008, according to the latest monthly forecast from the National Association of Realtors.

The group's July forecast, released Wednesday, is more pessimistic than its June forecast in nearly every aspect.
...
The realtors' press release was headlined "Home prices expected to recover in 2008 as inventories decline" -- even though the forecast median price for existing homes in 2008 was unchanged from last month's at $222,700.

by Tanta on 7/11/2007 10:32:00 AM

UBS has a report out today (not available on the web) which suggests the possibility of an alarming trend in recent (2007) RMBS issuance: while subprime issuance has dropped, as we expected, and "agency" issuance (the GSEs, mostly, are meant by the rather old-fashioned industry term "agency"), particularly of fixed-rate loans and the better quality hybrid ARMs, is edging up as a share of the market, which we also expected, non-agency Alt-A is actually increasing as well, which is somewhat more surprising. At the same time Alt-A volume is creeping up, its credit quality shows some signs of deteriorating. The implication is that loan production that would, last year, have ended up in a subprime security is migrating into Alt-A securities.

In one sense this is hardly surprising: the line between Alt-A, "Alt-B," and subprime has never been sharply clear, as loan quality and underwriting standards operate on a continuum and different participants bucket the loans in somewhat different ways. I put the term "Alt-B" in quotation marks because, while some of you may have heard the term before, it's not universally popular in the industry. Traditionally, credit quality at the level of individual homeowners used letter grades, more or less uniformly, of "A" to mean "prime" credit, "A-" to mean near-prime (FHA programs, for instance, were historically considered near-prime), and "B" and "C" to mean subprime. (There is "D," which has always been considered "hard money" lending, not typically a kind of loan made by institutional mortgage lenders of any sort.) You can, of course, put plusses or minuses on any of these letters, if you want to denote the top or bottom of a range of credits.

Under this kind of rubric, the term "Alt-A" was originally seized upon as a way of describing loans that we used to just call "non-agency." The "A" part indicated prime borrower credit quality, supposedly comparable to the credit quality demanded by the GSEs, but the "Alt" part meant that other characteristics of the loan, apart from borrower credit quality, exceeded the guidelines required by the GSEs. Most famously, these were the high-LTV or CLTV stated income deals. "High LTV" is of course relative to things like occupancy: while the GSEs accept a lot of high-LTV primary residences, they have always been less interested in high-LTV second home or investment properties. So Alt-A has always included much larger percentages of non-owner-occupied loans.

You can see why "Alt-B" is an odd concept, then: the GSEs don't, as a general rule, securitize "B" credit loans. (They do invest in some subprime securities for their retained portfolios, which provides some liquidity for high-rated subprime tranches, but they didn't issue those securities and they don't own the residuals.) So "B" credit is by definition non-agency, whatever terms you offer. The term "Alt-B" is not an attempt to describe a kind of subprime lending as much as it is a derogatory term for the worst kind of officially-described "Alt-A," rather like the term "liar loan" is a derogatory term for the blander "no doc." If it has any clear definition, it generally refers to the lowest-quality segment of the somewhat nebulous "Alt-A" world.

My point is that there has for some time been quite a bit of low-quality Alt-A, enough that the term "Alt-B" has unofficially been used to describe it, but that the expectation has been that guideline tightening in the wake of regulatory guidelines and the general cratering of the housing market would have gone a ways toward bringing the "A" back to "Alt-A." Yet there are hints, at least, that we are possibly seeing the relabeling of subprime loans as Alt-A recently, given the loss of investor appetite for anything called "subprime."

It is, of course, possible that a certain percentage of loans "belonged" in Alt-A all along, but were steered to subprime in order to increase originator commissions or just to jazz volume. If that is so, then seeing those loans get steered back to Alt-A may well be only a matter of justice. I think there's undoubtedly some truth in this, but it seems questionable to me that the addition of "steered" loans into the Alt-A pipeline should more than compensate for the loss of production due to guideline tightening within Alt-A. Unfortunately, we'll probably just have to wait and see on this, but like the UBS analysts, I am concerned that there's still a fair amount of toxicity out there that is just getting relabeled. You can call it "Alt-B" if you want, but that just means it's subprime with high LTVs or reduced documentation, and the point of tightening was to get rid of that stuff, not to bump it up into so-called "Alt-A" securities.

One of the problems with both a slovenly use of terms and a kind of demonization of "The Subprime"--both of which we've seen in the mainstream business press for quite a while--is that it can, actually, enable this kind of problem. Investors are spooked over anything called "subprime," but still not spooked enough to do much due diligence on these deals, so you can easily get a situation in which shaky deals just migrate into the less-demonized category.

To me, the most troubling part of the S&P announcement yesterday was that it both conceded that the data it uses to analyze loan pools may be seriously corrupt, and basically had nothing to offer in terms of fixing that. Adding a fraud-prevention questionnaire to its review of mortgage originators isn't going to solve the problem of inflated appraisals, inflated income, manipulated FICOs, and just plain old half-assed data reporting in the absence of actual fraud. S&P knows this perfectly well, but they (and the other rating agencies) have never been in the business of loan-level due diligence or serious auditing of originators or issuers, and they're not in the position to start now.

As I have argued before, we as an industry have known how to prevent a lot of fraud for a long time; we just didn't do it. It costs too much, and too many bonuses were at stake to carve out the percent of loan production it would take to get a handle on fraud. The only thing that got anybody's attention, finally, was a flood of repurchase demands on radioactive EPD loans and other violations of reps and warranties. If S&P wants to accomplish something, I'd suggest skipping the fraud-detection questionnaire directed to the mortgage originators (they'll just make up good answers to it, for heaven's sake, if they have inadequate operations, and the rating agencies can't verify it), and start slapping some issuers around on their pre-purchase or pre-securitization quality control and due diligence. If you want reliable loan-level data to do your ratings analysis with, you make it expensive for people to give you cruddy data.

by Calculated Risk on 7/10/2007 09:25:00 PM

From Dow Jones: US Broker-Dealer Circulating List Of Subprime Bonds For Sale. Some excerpts:

In what one investor characterized Tuesday as a "fire sale," a broker dealer - which the investor said was John Devaney's United Capital Markets ... circulated a list of subprime mortgage bonds for sale.
...
The low prices of the bonds may point to a continued broad-based cheapening of the whole subprime sector.
...
The offering was for 11 different classes of bonds totalling $82 million, including $10 million in below-investment-grade subprime mortgage-backed bonds from an Ameriquest Mortgage issuer at 58 cents on the dollar.

Other below-investment-grade bonds from separate issuers were listed as sold, with final offering prices for two such bonds listed at 45 cents and 28 cents on the dollar. There was also $32 million in AAA-rated bonds listed at 92 cents on the dollar.

by Tanta on 7/10/2007 05:00:00 PM

New York, July 10, 2007 -- Moody's Investors Service today announced negative rating actions on 431 securities originated in 2006 and backed by subprime first lien mortgage loans. The negative rating actions affect securities with an original face value of over $5.2 billion, representing 1.2% of the dollar volume and 6.8% of the securities rated by Moody's in 2006 that were backed by subprime first lien loans.

Of the 431 rating actions taken today, Moody's downgraded 399 securities and placed an additional 32 securities on review for possible downgrade. One of the downgraded securities remains on review for possible further downgrade. The vast majority of rating actions taken today impacted securities originally rated Baa or lower. The 239 securities originally rated Baa on which action was taken represented 19% of the total number of Baa ratings issued in 2006; the 185 securities originally rated Ba on which action was taken represented 42% of the total number of Ba ratings issued in 2006; and, the 7 securities originally rated A on which action was taken represented 0.6% of the total number of A ratings issued in 2006. No action was taken on securities rated Aaa or Aa. . . .

Recent data shows that the first lien subprime mortgage loans securitized in 2006 have delinquency rates that are higher than original expectations. Those loans were originated in an environment of aggressive underwriting. This aggressive underwriting combined with prolonged, slowing home price appreciation has caused significant loan performance deterioration and is the primary factor in these rating actions. In addition, Moody's analysis shows that the transactions backed by collateral originated by Fremont Investment & Loan, Long Beach Mortgage Company, New Century Mortgage Corporation and WMC Mortgage Corp. have been performing below the average of the 2006 vintage and represent about 60% of the rating actions taken today. . . .

Moody's has noted a persistent negative trend in severe delinquencies for first lien subprime mortgage loans securitized in 2006. For example, the 90+ day delinquency rate for loans securitized in 2006 has increased from 7.9% in March 2007 to 10.8% in May 2007. However, losses have remained relatively low, with the May cumulative loss rate reaching only 0.30%.

As part of the recently completed review of all 2006 subprime RMBS, Moody's said it examined the portion of each pool that was severely delinquent -- that is, over 90 days past due, in foreclosure or held as "real estate owned" -- and assessed the amount of credit enhancement available to the rated tranches in the form of subordination and excess spread. "Early defaulting borrowers often exhibit distinct characteristics: they are more likely to be first-time home buyers, speculators, or are over-leveraged or have 80%-20% first-second lien loan combinations," said Weill. Consequently, the early defaulters may exhibit different behavior than other borrowers in the pool. Those borrowers may face other challenges in the next few months when rate and payment resets take effect, especially in the absence of effective loan modifications.

In analyzing loans that are severely delinquent, Moody's said it considered a number of scenarios based on various assumptions about the percentage of currently delinquent loans that would eventually default (the "roll rate") and the expected severity of loss given default. The roll rates used were: for over 90 days delinquent: 50%, 75% and 90%; for those loans in foreclosure and held as real estate owned: 95% and 100%. While these roll rates are higher than those that have been realized historically, Moody's believes that these loans, with their high vacancy rates and high "no contact" rates, are more likely to default than other subprime loans.

The severity rates Moody's assumed ranged from 25%-30% (in particular, for deals with strong coverage from mortgage insurance), to 40% (for most originators), to 50% for originators whose mortgage assets are revealing particularly high severe delinquency rates.

For the portion of each pool that is not severely delinquent, Moody's increased its original loss expectations for the pool by a stress factor of 20% which is consistent with the increased loss expectations that the rating agency published in its March 2007 report: "Challenging Times for the US Subprime Mortgage Market."

While we considered both the projected losses associated with the seriously delinquent loans (the "pipeline losses") as well as the projected losses associated with the remaining portion of the pool, we gave more weight to the pipeline losses.

by Calculated Risk on 7/10/2007 04:08:00 PM

Rex Nutting at MarketWatch comments on the new S&P rating change: New methodology is death knell for the troubled industry

Standard & Poor's just drove a huge harpoon into the heart of the mortgage credit bubble, and it's going to take a long time to clean up the mess once the beast finally dies.

... S&P isn't going along with the charade anymore. S&P said it would change its methodology for rating hundreds of billions of dollars in residential-mortgage-backed securities. And it would review its ratings on hundreds of billions of dollars in the more complex collateralized debt obligations based on those subprime loans.

A lot of debt will be downgraded to junk status. ...

S&P's announcement is a death warrant for the subprime industry.

I'm looking forward to Tanta's further comments on the new S&P methodology.