by Calculated Risk on 11/08/2007 03:43:00 PM

Here are some headlines (hat tip Brian) from the Toll Brothers Conference call:

Click on photo for larger image.

The audio of the conference call should be available here soon.

I miss Ivy Zelman and her KoolAid comments! Note: Ms. Zelman (while at Credit Suisse) confronted Toll Brothers CEO Bob Toll during an analyst conference call in 2006 by asking: "Which Kool-aid are you drinking?"

by Calculated Risk on 11/08/2007 02:04:00 PM

The Census Bureau, during periods of rising cancellation rates, overstates New Home sales and understates the increase in inventory. Conversely, during periods of declining cancellation rates, the Census Bureau understates sales. Here is discussion from the the Census Bureau on cancellations. Note: this shouldn't be confused with revisions that are unrelated to cancellations.

Using cancellation rates from several of the publicly traded home builders, we can estimate the actual new home inventory (as opposed to the inventory reported by the Census Bureau). Note: The Census Bureau breaks down the inventory as Completed, Under Construction, and Not Started. The following chart show the reported and cancellation adjusted inventory levels for the hard inventory (excluding the "Not Started" category).

Click on graph for larger image.

At the end of Q3, this analysis shows the Census Bureau is currently understating the hard inventory of new home sales by about 100,000 units. Even though the Census Bureau data indicated a slight decline in new home inventory in the third quarter, the adjusted inventory increased because of rising cancellation rates.


The second graph shows the reported Months of Supply for new homes, and the adjusted Months of Supply based on homebuilder cancellations. At the end of Q3, the Census Bureau reported the seasonally adjusted Months of Supply for new homes was 8.3 months. Adjusting for cancellations, the actual months of supply was 11.0 months!

However, it isn't just the inventory of new homes for sale that will impact the homebuilders. Existing homes are a competing product for new homes, and the record inventory of existing homes for sale will also pressure home-building activity. Also, it's not just the level of inventory that matters, but also the level of distressed inventory. We are already seeing record levels of foreclosures in some states, and IMO it is about to get much worse. I'll have more on total and distressed inventory soon.

by Calculated Risk on 11/08/2007 11:22:00 AM

From MarketWatch: Toll's home orders drained by cancellations

Toll Brothers ... said Thursday its net orders for new homes in the latest quarter fell 35% from a year earlier as cancellations increased, pointing to further losses in the residential housing market.

"We continue to believe that excess supply created by cancellations, speculative buyers, and overly ambitious builders; customer concerns about selling their existing homes; and a general lack of confidence are the primary impediments to our market's recovery," said Chief Executive Robert Toll in a statement.

He said tighter lending standards and inability to obtain mortgages as a result of the subprime mess do not appear to be a "major factor" affecting its mostly affluent buyers. However, he said a tougher mortgage market may make it more difficult for buyers to sell their existing houses and move into a Toll house.
...
The builder had 417 cancellations during the quarter, while net contracts totaled 656 homes. Toll said the cancellations were heavily concentrated in high-priced markets and product lines.

"Unfortunately, the pace of customer cancellations increased in this fourth quarter," Rassman said. "We, and other reporting builders, have observed that October's activity appeared weaker than September's. These trends suggest that we still have challenging times ahead, which we believe are reflected in our estimates for fourth quarter impairments."

First, these higher cancellations mean the New Home inventory numbers from the Census Bureau will be too low. See this discussion on how the Census Bureau handles cancellations. Note: Toll is one of the companies I use to calculate the adjusted New Home inventory. I should have an update for Q3 soon.

Second, Toll is probably correct about the minimal direct impact of tighter lending standards on high end homes. However, as Toll noted, if the high end buyers can't sell their homes, they can't buy Toll's homes.

by Calculated Risk on 11/08/2007 10:59:00 AM

From MarketWatch: U.S. faces risks of downturn, inflation: Bernanke

The U.S. economy not only faces the risk of a sharp slowdown from the housing market's contraction but also of an inflationary surge from sharply higher crude-oil prices and the weaker dollar, Federal Reserve Chairman Ben Bernanke said Thursday.
...
Bernanke said that he and his colleagues on the policy-setting Federal Open Market Committee expect the economy to slow "noticeably" from the third-quarter growth rate and remain sluggish in the first half of 2008. But Bernanke also suggested that the hawkish members of the Fed might have a point about inflation.

There were downside risks to the subdued growth forecast, and upside risks to the benign inflation outlook, Bernanke said.
...
He noted that prices for crude oil and other commodities have risen sharply in recent weeks and that the dollar has weakened in foreign-exchange markets.

"These factors were likely to increase overall inflation in the short run and, should inflation expectations become unmoored, had the potential to boost inflation in the longer run as well," Bernanke said.
...
Bernanke bluntly said that headline inflation is going to rise in the short term.

Here is Bernanke's Speech: The economic outlook

by Tanta on 11/08/2007 09:46:00 AM

Via PJ at Housing Wire, I see that WaMu put a PR out yesterday on the matter of Mr. Cuomo's investigation into its appraisal practices. As PJ notes, this is the part that matters:

The contract with the vendor named by the NY AG requires that the vendor represent and warrant that appraisals are prepared in compliance with Uniform Standards of Professional Appraisal Practice and all guidelines issued by Fannie Mae and Freddie Mac. The contract also requires that the appraisals have been prepared without fraud or negligence on the part of the vendor, its employees or agents, including any appraiser.

Fewer than 5 percent of the appraisals performed under this contract were related to subprime loans.

WaMu has a very rigorous process regarding all repurchase requests and believes it is adequately reserved for such liabilities.

That last sentence is clearly a direct response to the last sentence of this part of Fannie Mae's PR from earlier yesterday:

It is against our interest to purchase or guarantee mortgages with inflated appraisals, and so it is in Fannie Mae's interest that these appraisal practices be investigated. The Attorney General has indicated that he also plans to subpoena Fannie Mae for documents and testimony related to the appraisal process. We intend to cooperate fully with the Attorney General. We also will appoint, with the Attorney General's approval, an independent examiner to review the appraisal practices cited in the complaint. If the examiner determines we own or guarantee mortgages with inflated appraisals, our guide states that the lender must buy back the loans that do not meet our standards and requirements.

In other words, Fannie Mae is saying that WaMu will take back any loans with dubious appraisals this "independent examiner" digs up. WaMu is saying that it will "rigorously" avoid doing so.

WaMu is also saying, in effect, that it signed a contract with eAppraiseIT that puts all liability for inflated appraisals on eAppraiseIT. Fannie Mae is saying, in effect, that it signed a contract with WaMu that puts all liability for inflated appraisals on WaMu. Cuomo, you note, is pursuing a civil complaint against eAppraiseIT and its parent First American, not against WaMu or Fannie Mae.

This is very interesting precisely because it isn't going to be about inflated appraisals. It's going to be about how far anyone can get away with two practices that are the lynch-pins of the mortgage industry: outsourcing regulatory liability to a third party bag-holder and doing business on a representation and warranty basis without pre-sale due diligence.

Neither Fannie Mae nor Freddie Mac nor most any other secondary market participant actually examines appraisals on individual loans prior to purchasing them. Some percentage of loans are chosen after purchase for a "Quality Control" review; if problems are found at that point, the investor demands that the seller repurchase (or indemnify) the loan.

This process works only to the extent that the representations made in the loan sale contract are clear, specific, and wide enough to capture all the serious problems an investor might have with a loan. In Fannie and Freddie's case, the loan seller represents that the loan meets every guideline currently published by the GSE or specified in the individual contract. The Fannie and Freddie guides themselves run to hundreds and hundreds of pages; in the case of something like appraisals, the GSE guidelines incorporate by reference things like USPAP (the standards promulgated by the Appraisal Foundation), which themselves run to a lot of pages.

Trust me; all of that stuff is detailed and specific enough that it isn't that hard to find contractual grounds to declare breach and demand repurchase of a loan. WaMu knows that perfectly well, as do all mortgage lenders: those loan sale contracts with all those warranties against all those representations add up to major potential repurchase liability. And the ugly thing is that it's repurchase liability. If your loans were all subject to 100% pre-purchase detailed QC review, your risk would be that the squirrelly ones get kicked out of the sale (you don't get to sell them). Post-purchase QC based on rep & warrant means you risk having to take them back in the future, at par, when they might be worth 90 cents on the dollar (or less), at exactly the wrong time to be owning nuclear waste. It's just like foreclosures: lenders don't make money on REO because they don't own much REO except in time periods when RE is worth a lot less, since they wouldn't be foreclosing so much if the RE market were hummin' along.

WaMu's statement is that it took all the "warranty" part of all of this off its own back and put it onto eAppraiseIT's. The plan all along was that if Fannie Mae (or anyone else) tried to force these loans back because of appraisal problems, WaMu would make eAppraiseIT take the losses. In essence, eAppraiseIT was writing an "appraisal default swap." Pity there's no public index for ADS like there is for CDS: I'm sure that would be some interesting cliff diving.

Anyway, this is why the whole flap is scaring the panties off everyone in the mortgage industry, far, far beyond any worry over stiffer appraisal regulation. The core issue here is a cornerstone of the whole "originate and sell" model that has created such a crisis. If Cuomo's suit makes any headway at all, it will put eAppraiseIT out of business one way or the other. That's because if appraisal management companies are no longer willing or able to write these liability swaps into their contracts, they won't be able to offer what the lenders really want from them. The advantage of doing business this way isn't really about saving a few dollars on outsourcing administrative work for the lenders, it's about getting out from under a huge expensive compliance and legal risk.

No wonder Cramer's head is exploding again. This thing really isn't about appraisals, it's about stopping the game of risk-layoff. The weakest (financially and politically) party in the chain, eAppraiseIT, appears to have taken on all the residual risks from WaMu and Fannie Mae, and now Cuomo is going to force those losses to materialize. You can bet that every General Counsel at every mortgage lender still operating is busy reviewing many, many contracts right now. The results will be very, very ugly.

by Calculated Risk on 11/07/2007 09:05:00 PM

From Reuters: Merrill reveals $6.3 billion more in subprime-CDO exposure

Merrill Lynch ... said its total exposure to risky collateralized debt obligations and subprime mortgages is $27.2 billion, or about $6.3 billion more than what the company disclosed late last month.

Merrill's larger figure is mostly because ... the world's largest brokerage disclosed $5.7 billion worth of exposure to U.S. subprime mortgages at Merrill Lynch Bank USA, a Utah-chartered industrial bank, and Merrill Lynch Bank & Trust Co., a full-service thrift.
...
Mike Mayo, an analyst at Deutsche Bank, has estimated that Merrill's additional write-down could top $10 billion.

Just a note: Mayo has been doing a great job.

by Calculated Risk on 11/07/2007 06:44:00 PM

From the WSJ: Morgan Stanley to Take $3.7 Billion Write-Down

Morgan Stanley will take a $3.7 billion write-down in the fourth quarter ... [from] its exposure to the U.S. subprime market.

The investment bank ... said it could lose up to $6 billion if all subprime mortgage-related investments go bad.

This is within the forecast range, from the WSJ yesterday: Morgan Stanley May Take Hit From Subprime

Two analysts are projecting the firm may take a fourth-quarter write-down of $3 billion to $6 billion. The estimates by analysts David Trone of Fox-Pitt, Kelton and Mike Mayo of Deutsche Bank AG ...
...
Another research firm, CreditSights, yesterday estimated potential fourth-quarter CDO hits at $9.4 billion for Merrill, $5.1 billion for Goldman, $3.9 billion for Lehman, $3.8 billion for Morgan Stanley and $3.2 billion for Bear Stearns.

by Calculated Risk on 11/07/2007 03:27:00 PM

From MarketWatch: Moody's cuts more SIV ratings (hat tip REBear, sr)

Moody's ... downgraded more ratings on structured investment vehicles on Wednesday and warned that the funds are in a more precarious position than they were in early September, previously considered the height of this year's credit crisis.

Moody's said it cut or may downgrade ratings on structured investment vehicles (SIVs) with roughly $33 billion in debt. ... More than 10% of all SIV debt was affected by the move. ...

"The situation has not yet stabilized and further rating actions could follow," Moody's said in a statement. "SIV senior note ratings continue to be vulnerable to the unprecedented large and sustained declines in portfolio value combined with a prolonged inability to refinance maturing debt."

From Bloomberg yesterday: Citigroup SIVs Draw $7.6 Billion of Emergency Funds

Citigroup Inc., the largest U.S. bank by assets, provided $7.6 billion of emergency financing to the seven structured investment vehicles it runs after they were unable to repay maturing debt.

The SIVs drew on the $10 billion of so-called committed liquidity provided by Citigroup ...

This is getting ugly. Also the MLEC SIV Superfund has apparently stalled as the SIV situation is deteriorating. (sorry for all the posts today - a lot of news and little analysis)

by Calculated Risk on 11/07/2007 01:29:00 PM

Here is the press release from NY AG Cuomo. A couple of excerpts:

“Our expanding investigation into the mortgage industry has uncovered that Washington Mutual improperly pressured appraisers to provide inflated values that best served the lender’s interest. Knowing this, Fannie Mae and Freddie Mac cannot afford to continue buying Washington Mutual mortgages unless they are sure these loans are based on reliable and independent appraisals.”
Attorney General Cuomo, Nov, 7, 2007

And from the Appraisal Institute:

“I wish I could say I am shocked by the discoveries made by the Attorney General and his staff. Sadly, what allegedly happened between First American and Washington Mutual is not an isolated incident. Rather, it is symbolic of a problem that has plagued the appraisal industry for years. As the allegations against First American show, the mortgage industry’s dirty secret has been that banks exert tremendous pressure to extort appraisers.”
Terry Dunkin, President of the Appraisal Institute Nov 7, 2007.

by Calculated Risk on 11/07/2007 01:10:00 PM

From Bloomberg: Banks Face $100 Billion of Writedowns on Level 3 Rule, RBS Says

U.S. banks and brokers face as much as $100 billion of writedowns because of Level 3 accounting rules, in addition to the losses caused by the subprime credit slump, according to Royal Bank of Scotland Group Plc.

And on total credit losses:

``This credit crisis, when all is out, will see $250 billion to $500 billion of losses,'' London-based Janjuah said. ``The heat is on and it is inevitable that more players will have to revalue at least a decent portion'' of assets they currently value using ``mark-to-make believe.''

Back in July, when Bernanke suggested the losses would be in the $50 Billion to $100 Billion range, I joked that he had dropped a zero.

"Some estimates are in the order of between $50 billion and $100 billion of losses associated with subprime credit problems," [Bernanke] said (July 19, 2007).

I thought I was exaggerating for effect - although $50 to $100 Billion seemed too low, I didn't really think the losses would reach $500 Billion to $1 Trillion. Based on this new estimate from RBS, maybe I wasn't far off.

Note: these losses don't include the coming $2+ Trillion in household net worth losses due to house prices falling over the next couple of years.