by Tanta on 12/28/2007 08:45:00 AM

A quite decent piece on Option ARMs in the LA Times. I liked this part:

Despite such risks, the initial low payments on option ARMs have kept a lid on serious delinquencies -- 3.7% of all option ARMs, Standard & Poor's analysts said in a report last week. That's higher than before, but still low compared with the 6.3% delinquency rate on loans to good-credit borrowers with so-called hybrid ARMs, which have a low fixed rate for two to 10 years before becoming adjustable-rate loans.

At Calabasas-based Countrywide Financial Corp., which S&P said made about a quarter of all option ARMs last year, 3% of such loans held by the lender as investments were delinquent at least 90 days, up tenfold from 0.3% a year earlier. Delinquency rates were even higher on option ARMs from other lenders, including Pasadena-based IndyMac Bancorp and Seattle's Washington Mutual Inc., S&P said.

Countrywide and other lenders tightened their lending standards last summer to ensure borrowers could afford loans after the interest rates adjusted upward.

Had those guidelines been in effect previously, Countrywide recently said, it would have rejected 89% of the option ARM loans it made in 2006, amounting to $64 billion, and $74 billion, or 83%, of those it made in 2005.

I made an argument a while ago that focussing regulator attention exclusively on disclosure documents can be just a touch beside the point if lenders are no longer offering the product in question. You have to wonder, if we just cut off 80-90% of the OA borrower pool, whether the remaining 10% really need those new and improved disclosures, or can muddle along with the ones already in use. If you take the OA out of the mass market and put it back into the high-net worth, high-income crowd it was originally designed for, you might find that your borrowers are already selected to be people who either read and understand disclosures, or who hire an attorney or financial planner to read them. I can certainly think of better uses for regulators' time and energy than fooling around with disclosure documents that would be clear to borrowers who are now in a rather different kind of trouble than not understanding the teaser rate on their OA.

The other thing to notice is that the obligatory example borrower supplied in the article is having trouble with her first payment increase (the typical 7.5% annual increase in the minimum payment), which is still not enough to cover all the interest due. As that sort of situation increases (as more and more 2005-2006 vintage OAs get to their second or third payment increase), we'll start seeing defaults long before the recast date.

Speaking of which, when I am not making cartoon pigs I have been creating some spreadsheets to show examples of how to project the recast date on Option ARMs. That's total and compleat Nerd territory, but if anyone is interested I'll post them (as spreadsheets or as images thereof). You tell me whether that's more detail than you can stand or not.

by Tanta on 12/28/2007 08:14:00 AM

Floyd Norris, New York Times, December 28, 2007:

What if it’s not just subprime?

Gee Willikers. If it's not just subprime, there might be enough material in it to, oh, fill a whole blog. Or several dozen of them.

by Calculated Risk on 12/27/2007 02:56:00 PM

Update: from Reuters: Moody's may cut Technical Olympic deeper into junk (hat tip Mike)

From Bloomberg (no link yet, hat tip Brian): TOUSA, Florida Homebuilder, May See Rating Reduction

TOUSA ... will see its debt rating slashed to default status if it fails to make Jan. 1 interest payments on senior notes, Standard & Poor's said today.
...
TOUSA is considering several restructuring options, including a potential Chapter 11 filing, S&P said.

TOUSA was the #13 largest builder in 2006 according to BuilderOnline. I believe the largest home builder to go bankrupt so far was #50 Levitt & Sons. Here is the BuilderOnline top 100.

by Calculated Risk on 12/27/2007 01:02:00 PM

From the Fed weekly report on commercial paper this morning, here is the discount rate spread:

Click on graph for larger image.

According to the Fed, the discount rate spread is 145 bps. This graph was released this morning.

Here is a simple explanation of this chart: This is the spread between high and low quality 30 day nonfinancial commercial paper.

What is commercial paper (CP)? This is short term paper - less than 9 months, but usually much shorter duration like 30 days - that is issued by companies to finance short term needs. Many companies issue CP, and for most of these companies the risk of default is close to zero (think companies like GE or Coke). This is the high quality CP. Here is a good description.

Lower rated companies also issues CP and this is the A2/P2 rating. This doesn't include the Asset Backed CP.

The spread between the A2/P2 and AA paper shows the concern of default for the A2/P2 paper. Right now the spread is indicating that the fear of default is very high. Higher than in August. And higher than after 9/11.

by Calculated Risk on 12/27/2007 10:45:00 AM

It's been some time since I graphed the weekly claims numbers.

From the Department of Labor:

In the week ending Dec. 22, the advance figure for seasonally adjusted initial claims was 349,000, an increase of 1,000 from the previous week's revised figure of 348,000. The 4-week moving average was 342,500, a decrease of 1,000 from the previous week's revised average of 343,500.

Click on graph for larger image.

This graph shows the weekly claims and the four week moving average of weekly unemployment claims since 1989. The four week moving average has been trending upwards for the last few months, and the level is now approaching the possible recession level (approximately 350K).

Labor related gauges are at best coincident indicators, and this indicator suggests the economy is close to recession.

by Tanta on 12/27/2007 10:00:00 AM

The WSJ (sub only, I'm afraid) had a piece yesterday on a process it never actually names--the "short refi" (related to the "short sale"). What makes these short refis--refinance transactions where the new loan is less than the balance due on the old loan, with the old lender agreeing to call the loan paid in full and write off the difference--so unusual is that the old loans are nasty high-rate subprime loans to old people, and the new loans are reverse mortgages.

The strategy worked recently for Gloria Forts, a 62-year-old retired federal worker in Forest Park, Ga., a suburb of Atlanta. After refinancing her home in August 2006 with a $106,500 mortgage from Fremont Investment & Loan in Brea, Calif., Ms. Forts was facing monthly payments of $950.41. That consumed 70% of her monthly income from Social Security and a pension. Intending to start a new job, she found herself kept at home by diabetes complications and back surgery. In June, she sought help from the Atlanta Legal Aid Society.

There, she found William J. Brennan Jr., a veteran housing attorney who, over the past 18 months, has developed a sophisticated model for settling subprime debts with reverse mortgages. After Ms. Forts received a foreclosure warning in October, Mr. Brennan connected her with Genie McGee, a reverse-mortgage specialist with Financial Freedom Senior Funding Corp., an Irvine, Calif., unit of IndyMac Bancorp Inc. She determined that Ms. Forts would qualify for a reverse mortgage of about $61,000.

Mr. Brennan sent Fremont's loss-mitigation department a letter proposing that the company agree to take that sum and cancel its plans to foreclose on the house. On Dec. 3, the day before the foreclosure sale was supposed to take place, Fremont agreed to the deal and stopped the foreclosure.

Using a reverse mortgage as a foreclosure workout is certainly unusual. I've written about reverse mortgages here if you're not familiar with the beast. They were designed for older borrowers (the minimum age is 62 for all products I know about) who are house-rich but cash-poor. Using them for borrowers who are house-poor, to prevent foreclosure, isn't exactly what they were intended for. And using them to "create" an equity cushion that they can then absorb in deferred interest is quite the innovation. (Of course the "equity" here isn't being "created"; it's being "donated" by the old lender.)

Then again, it isn't every historical moment in which lenders are willing to accept 57 cents on the dollar on a short refi, either. The key to the reverse mortgage is that the maximum loan amounts are much lower, on the whole, than they are for forward mortgages. (Because the amount that can be borrowed is a function of both the value of the home and the age--the likely remaining lifespan--of the borrower, only the very very old can borrow as much with a reverse mortgage as with a forward mortgage.) The WSJ doesn't give the current appraised value of Ms. Forts' property, but I'd guess that the original LTV of the new $61,000 reverse mortgage is not much more than 50% (suggesting that the old $106,500 mortgage, which apparently carried an interest rate of 10% or so, was around 90% of current value). It says a lot about Fremont's estimate of loss severity that they took the money and ran.

Is this a good deal for Ms. Forts? Well, she gets to stay in her house. (She might describe this as getting to "keep" her house, but the way a maximum-balance reverse mortgage to a 62-year-old borrower is likely to work, statistically, what she just did, in effect, was give the deed to IndyMac while reserving a life estate.) She is highly unlikely ever to be able to withdraw cash again from it; at her age and that loan balance, my guess is that compounding interest on the original balance will far outstrip any possible positive appreciation on that property in Ms. Forts' lifetime, and her heirs will simply hand over the deed to the bank.

What I find mildly amusing is that the WSJ reporter almost, but not quite, gets the issue here:

With a reverse mortgage, the bank makes payments to the homeowner instead of the homeowner making payments to a bank. The loan is repaid, with interest, when the borrower sells the house, moves out permanently or dies. The products are complex and have high fees -- typically about 7% of the home's value -- and they make it difficult for homeowners to leave the property to their heirs. But they may be the best option for people who have built up equity in their home and would otherwise lose it.

Actually, a reverse mortgage doesn't make probate any harder than a forward mortgage does. It's not that it's "difficult" to leave the property to the heirs; it's that the loan amount is likely to be equal to or more than the property's value at that point. Notice the odd phrasing of that last sentence: grammatically, "it" probably refers to "equity," but that of course is going to be lost in all cases (except for borrowers unfortunate enough to die prematurely; one hopes that doesn't make the heirs happy). The only thing a reverse mortgage borrower "keeps," in practical terms, is occupancy.

This is also curious:

The transaction illustrates one of the biggest challenges in getting lenders to accept payouts from reverse mortgages: taking less money than the house may be worth.

My sense is that the WSJ reporter just can't really wrap her mind around the reality of the mortgage and housing markets today. This business of "taking less money than the house may be worth" (as opposed to "taking less than the loan amount") may just be sloppy phraseology, but I think it's kind of sypmtomatic of how hard it really is for some folks to shed the assumptions of the Boom. Short refis are going on all around us, not just with reverse mortgages: a lot of the loans going into FHASecure, for instance, are short (by the amount of some or all of a second lien, often, but in some cases even the first lien payoff is short). I'm surprised that you still have to say this out loud to people, but what "the house is worth" is no longer a particularly relevant concern for a lot of people. The issue is what you owe, and as long as there are places in the world where expected loss severity to lenders can be in the neighborhood of 47% of the loan amount, you probably owe too much.

by Calculated Risk on 12/27/2007 09:30:00 AM

From Bloomberg: ACA Gives Control to Regulator to Avert Delinquency

ACA Capital Holdings Inc., the bond insurer that lost its investment-grade credit rating last week, agreed to give control to regulators to avert delinquency proceedings.

ACA Financial Guaranty Corp., a unit of ACA Capital, will seek approval from the Maryland Insurance Administration before pledging or assigning assets or paying dividends, the New York- based company said in a filing with the Securities & Exchange Commission yesterday.

by Calculated Risk on 12/26/2007 10:26:00 PM

From Reuters: Fitch may cut ratings on some insured mortgage bonds

Fitch Ratings on Wednesday said it may cut its ratings on certain residential mortgage-backed securities insured by MBIA Inc, Ambac Assurance Corp, FGIC Corporation and Security Capital Assurance.

Fitch said it may cut 87 MBIA-insured mortgage bonds, 64 Ambac-insured bonds, 35 FGIC-insured bonds and 19 SCA-insured bonds.

by Calculated Risk on 12/26/2007 02:21:00 PM

From "Business of the year" to closed in one year ...

From the AZCentral: Now closed, Re/Max was named 'Business of the Year in '06

The major Valley real estate brokerage that closed its offices days before Christmas had been named Business of the Year last year by the Chandler Chamber of Commerce.

Re/Max 2000, based in Gilbert, has closed its 13 offices around the Valley, including two in Chandler.

Owner Robert Kline began the company in 2000, and in September 2006, he said his projected sales for that year were $1.2 billion. At that time, he had 11 offices and 450 employees.

by Calculated Risk on 12/26/2007 02:01:00 PM

The first graph shows real house prices in Los Angeles based on the S&P/Case-Shiller house price index. Nominal prices are adjusted with CPI less shelter from the BLS.

Click on graph for larger image.

After the peak in December 1989, prices in Los Angeles fell 41.4% over about 7 years, in real terms (adjusted for inflation). (Note: using the OFHEO series, real prices declined 34% in LA in the early '90s).

So far, in the current bust, nominal prices have declined almost 9% in LA, and about 12% in real terms.

The second graph aligns, in time, the December 1989 price peak with the October 2006 peak.

The horizontal scale is the number of months before and after the price peak.

In 1990, real prices had declined 9.3% during the first 12 months after the price peak. For the current bust, real prices have declined 12% for the same period.

This suggests that price declines have just started, and that there will be several more years of price declines in the bubble areas.