by Calculated Risk on 2/05/2008 06:30:00 PM

From MarketWatch: S&P cuts Fremont General to CCC+; warns on liquidity (hat tip Carlomagno)

Standard & Poor's downgraded Fremont General to CCC+ from B- late Tuesday and warned that the Californian lender may not be able to meet its debt obligations. "Liquidity at the holding company has deteriorated substantially," S&P credit analyst Adom Rosengarten said in a statement. Liquidity remains strong at the company's banking business.

Here is a memo that was sent to me in Feb, 2007 when many people first started realizing there really was a mortgage problem. Of course, back then, many people mistakenly thought it was just a "subprime problem".

A couple of weeks after sending out that memo, Fremont announced they were postponing the release of results. And a couple of weeks later, the FDIC issued a Cease and Desist Order.

Ahhh, memories.

by Calculated Risk on 2/05/2008 04:04:00 PM

From Fitch:

Fitch Ratings announced today that in light of consensus movement towards a view of increased loss projections for U.S. subprime residential mortgage backed securities (RMBS) that is now held by various market participants and observers, including Fitch, that the agency will be updating certain modeling assumptions in its ongoing analysis of the financial guaranty industry. Fitch believes it is possible that modeled losses for structured finance collateralized debt obligations (SF CDOs) could increase materially as a result of these updated projections. The need to update loss assumptions at this time reflects the highly dynamic nature of the real estate markets in the U.S., and the speed with which adverse information on underlying mortgage performance is becoming available.

Fitch believes that a sharp increase in expected losses would be especially problematic for the ratings of financial guarantors -- even more problematic than the previously discussed increases in 'AAA' capital guidelines, which has been the primary focus of recent analysis of the industry. Expected losses reflect an estimate of future claims that Fitch believes would ultimately need to be paid by a guarantor. A material increase in claim payments would be inconsistent with 'AAA' ratings standards for financial guarantors, and could potentially call into question the appropriateness of 'AAA' ratings for those affected companies, regardless of their ultimate capital levels.

Fitch expects in addition to increases in expected losses, that its capital guidelines are likely to increase materially as well.

An increase in both expected losses and capital guidelines would place further downward pressure on the ratings of those five financial guarantors - Ambac Assurance Corp. (Ambac), CIFG Guaranty (CIFG), Financial Guaranty Insurance Co. (FGIC), MBIA Insurance Corp. (MBIA) and Security Capital Assurance Ltd. (SCA), the parent company of XL Capital Assurance Inc. - that Fitch has previously identified as having material subprime exposure within their insured portfolios. Ratings on three of these guarantors - Ambac, FGIC and SCA - were recently downgraded by Fitch, and their ratings remain on Rating Watch Negative. In separate releases in conjunction with this announcement, Fitch has also placed the 'AAA' insurer financial strength ratings of CIFG and MBIA on Rating Watch Negative.
emphasis added

This bears repeating: The new modeled losses could "call into question the appropriateness of 'AAA' ratings for those affected companies, regardless of their ultimate capital levels." Regardless of capital levels. That really says it all.

by Calculated Risk on 2/05/2008 01:53:00 PM

From Bloomberg: CDO Market Is Almost Frozen, Merrill, JPMorgan Say

Buying and selling of collateralized debt obligations based on mortgage bonds, high-yield loans or preferred shares has ground to a near-halt, traders said at the securitization industry's largest conference.

``We're definitely in a period of very low liquidity at the moment, which has actually been dropping precipitously in the last few weeks,'' Ross Heller, an executive director at JPMorgan Securities Inc., said yesterday ...

The credit crunch just won't go away. And just wait until some of the LBO debt blows up too.

Twenty-seven percent of the approximately $74 billion in bonds used in LBOs the last two years classify as ``distressed'' because they yield at least 10 percentage points more than Treasuries, Bloomberg data show.

by Calculated Risk on 2/05/2008 12:18:00 PM

From Jeffrey M. Lacker,President, Federal Reserve Bank of Richmond: The Economic Outlook for 2008

A particularly dramatic change is likely to occur in commercial construction, which is a key segment of business investment. Construction spending for new stores and offices grew by a healthy 10 percent after inflation last year, but we have heard reports from our District contacts of a significant softening of conditions lately, with major projects being deferred or cancelled outright. In addition, vacancy rates for retail space have increased over the last year, which should lead to less construction going forward. The most recent investment data we have are for December, and those reports indicate continued growth in construction activity and new orders for business equipment.
emphasis added

As Lacker notes, the December data for non-residential construction was still solid. Please allow me to repeat a couple of recent graphs to add to Lacker's point.

Click on graph for larger image.

This graph shows private residential and nonresidential construction spending since 1993 through December 2007.

Over the last couple of years, as residential spending has declined, nonresidential has been very strong.

As Lacker noted, as of December, a slowdown in nonresidential spending still hasn't shown up in the construction spending numbers.

But the second graph suggests Lacker's "dramatic change" in CRE investment is imminent.

This graph compares investment in non-residential structure with the Fed's loan survey results for lending standards (inverted) and CRE loan demand.

Based on Lacker's comments, it sounds like the CRE slump has arrived.

by Tanta on 2/05/2008 10:10:00 AM

I don't know why seeing the Chairman of the FDIC--that'd be the government agency that provides deposit insurance to banks and thrifts--on CNBC arguing with a billionaire investor about what is really in the best interests of billionaire investors is so damned funny, but this is classic teevee.

The Ross Plan, by the way, appears to involve the taxpayers buying a one-third participation interest in defaulting mortgages. That would mean that a private investor gets one-third of its principal back immediately, while the taxpayers get the right to collect one-third of a payment that isn't being made or one-third of foreclosure recoveries. But the beauty is that we know servicers will work harder to collect payments or maximize recoveries when the government is an investor in the pool, because it always works out that way, doesn't it?

OTOH, it's certainly more efficient than "mortgage food stamps."

Thanks, number2son!

by Calculated Risk on 2/05/2008 09:43:00 AM

From the WSJ: Service-Sector Activity Contracts

Service sector activity contracted sharply in January for the first time since March 2003.

... the Institute for Supply Management reported that its January nonmanufacturing index moved to a reading of 41.9, from December's 54.4.

...The report showed still problematic inflationary pressures in the non-manufacturing sector, with the prices index at 70.7, from the prior month's 71.5.

The employment index for January came in at 43.9, from December's 51.8.

The report also said that the non-manufacturing new orders index stood at 43.5. It was 53.9 in December.

It couldn't be much worse.

by Tanta on 2/05/2008 08:54:00 AM

P.J. at Housing Wire went to the American Securitization Forum conference because we weren't invited so we don't have to. A miscellaneous gem:

Jon Bottorff, managing director at HSBC Finance, during a session on mortgage origination, on walk-aways: “We’ve attracted a lot of borrowers who are really renters … It is disheartening as a servicer to see the willingness [to walk away] … [borrowers] simply don’t care.” Bottorff wants to see the mortgage industry “get back to the classic homeowner” who has a vested interest in staying in their home.

Yeah, and can we get back to the Classic Mortgage Lender™ who has a vested interest in something other than writing free puts? Just a thought.

Merrill Lynch senior director Sarbashis Ghosh, in a session on RMBS research: “It’s not a subprime problem, it’s a housing leverage problem … we have people with a mortgage who simply cannot afford to make their payments.” Ghosh suggested the solution was “to address the question of leverage,” and went so far as to suggest something like a food stamp program to help borrowers with payments.

And perhaps a Classic Investment Banker™ who understands that loans that are not government-insured are not, um, government-insured while we're at it? Can we have one of those, too? Can we? Can we?

by Calculated Risk on 2/04/2008 10:49:00 PM

Update: John Goodman at the NY Times reports on "a period of involuntary thrift".

... now the freewheeling days of credit and risk may have run their course — at least for a while and perhaps much longer — as a period of involuntary thrift unfolds in many households. With the number of jobs shrinking, housing prices falling and debt levels swelling, the same nation that pioneered the no-money-down mortgage suddenly confronts an unfamiliar imperative: more Americans must live within their means.

The WSJ reports: Credit Cards Are Playing Harder to Get

Big card issuers such as Citigroup Inc. are requiring higher credit scores before issuing new cards, particularly in states that have been hit hard by the housing downturn, including California, Arizona and Florida. Some lenders, including Bank of America Corp., are offering lower initial credit lines. Other lenders, such as Capital One Financial Corp., are limiting credit-line increases or reducing credit lines for existing customers if they see signs that they are suddenly applying for more credit or are having trouble paying down their balances. ...

Fewer applicants are being issued new cards: On average, credit-card approval rates have dropped to 32% of applicants from 40% a year ago ... This comes as issuers are doing fewer direct-mail solicitations to new customers. The number of such mailings fell about 16% ...

I don't know - my mailbox has been of full of credit card offers recently.

Click on graph for larger image.

This graph is from the Fed's Senior Loan Officer Opinion Survey on Bank Lending Practices and shows the net percentage of banks tightening lending standards for credit cards and other consumer loans.

So far standards are being tightened for other consumer loans more than credit cards. And, according to the Fed, tightening for consumer loans is minimal compared to the tightening for commercial real estate (CRE).

by Tanta on 2/04/2008 05:02:00 PM

Fed Governor Kroszner has delivered a speech on proposed new lending regulations from the Federal Reserve (using the authority granted to them to regulate under HOEPA, which specific authority they've had since the mid-90s, but now that the party's over it's a good time to get tough):

It would apply stricter regulations to higher-priced mortgage loans, which we have defined broadly. We were particularly interested in ensuring that protections remain strong over time as loan products and lending practices change. Our analysis of the data suggested that the troubles in the mortgage market generally arise not from a single practice in isolation, but instead from the complex ways that risk factors and underwriting practices can affect each other, sometimes called "risk layering." Therefore, we have proposed using a loan's annual percentage rate, or APR, to determine whether the loan is covered by stricter regulations.4 Because the APR is closely correlated to risk, the proposed protections would cover loans with higher risks rather than single out particular risk factors or underwriting practices.

With the APR thresholds we have proposed, we expect that the new protections would cover the entire subprime mortgage market and the riskier end of the "near prime" market, the latter also known as the "alt-A" market. Covering part of the alt-A market would anticipate possible actions by lenders to avoid restrictions on subprime loans priced near the threshold. It would also address real risks to consumers in the alt-A segment. This segment grew very rapidly, and it layered risks, such as undocumented income, on top of other risks, such as nontraditional loan structures allowing borrowers to defer paying principal and interest. . . .

The regulations would prohibit a lender from engaging in a pattern or practice of making higher-priced loans based on the value of the borrower's house rather than on the borrower's ability to repay from income, or from assets other than the house. This prohibition is intentionally broad to capture all risks to loan performance and the different ways that these risks can be layered. Moreover, the proposal avoids prescribing quantitative underwriting requirements. For example, the proposal would prohibit a pattern or practice of disregarding the ratio of applicants' income to their debt, but it does not prescribe a maximum ratio because the appropriate number depends heavily on other risk factors, which vary from loan to loan.

At the same time, the proposal does offer specifics. For example, it would create a presumption that a lender had violated the regulations if it engaged in a pattern or practice of failing to underwrite at the fully-indexed rate.5 This presumption is derived from the subprime guidance the agencies issued last year.

It bears emphasis, however, that our proposed regulations would be more robust and comprehensive than the guidance. The regulations would apply to all mortgage lenders, including independent mortgage companies. Guidance, in contrast, does not ensure uniformity of coverage. Moreover, the regulations would be legally enforceable by supervisory and enforcement agencies. Just as important, the regulations, unlike the guidance, would be legally enforceable by consumers. Borrowers who brought timely actions could recover statutory damages for violations, above and beyond any actual damages they suffered.

The proposed requirement to assess repayment ability is intended to protect consumers from abusive practices while maintaining their access to responsible credit. We recognize that satisfying both objectives at the same time is a challenge. The proposed rule's potential for consumer actions, coupled with its careful avoidance of prescribing quantitative underwriting thresholds, could raise compliance and litigation risk. In turn, this could raise the cost of credit for higher-risk borrowers or limit the availability of responsible credit. That is why we have proposed prohibiting a "pattern or practice" of disregarding repayment ability rather than attaching a risk of legal liability to every individual loan that does not perform. This approach is meant to preserve choices for borrowers with shorter or weaker credit records while protecting them from lenders who have a practice of disregarding repayment ability or are found to exhibit a pattern of unaffordable loans. . . .

It is not too early to emphasize that the effectiveness of the final rule will depend critically on effective enforcement. The Federal Reserve will do its part to ensure compliance among the institutions it supervises. We also have been instrumental in launching a pilot project with other federal and state agencies to conduct consumer compliance reviews of non-depository lenders and other industry participants. I am sure we will be aided in these efforts by a new system for registering and tracking mortgage brokers recently launched by the Conference of State Bank Supervisors.

The proposed regulation does extend to all mortgage lenders, not just federally-supervised depositories. However, the general standard in a number of places is whether a lender engages in a "pattern or practice" of problematic lending practices, not any individual instance of it. It is therefore meaningless without a regulatory structure of some sort for each kind of lender that can examine large samples of the lender's loans in a long enough period of time to discern patterns, however those end up being defined. (1 in 100 loans? Every other loan? Something in between? What constitutes a "pattern"?) I am not particularly comforted by the idea that all we have at the moment is a "pilot project" to examine non-depository lenders.

The meatiest prohibitions (limiting stated income and prepayment penalties and requiring tax and insurance escrows) apply only to "higher-priced mortgages." In essence, as long as a lender consistently underprices its risk, it gets to write all the stated-income, prepayment penalty, no-escrow loans it wants to. Theoretically, at least, regulators of federally-insured depositories would be on top of the pricing problem during a safety and soundness examination.

However, that doesn't mean that non-depositories would be subject to examination of risk-based pricing models. Nor does it seem to give those examiners who do look at these things much guidance for when risk is underpriced. The logic, apparently, is that: 1) consumers are not harmed by underpriced risk and 2) consumers are harmed by absolute prohibition on stated income, prepayment penalties, and escrow waivers. It seems to me that 1) can be plausible only if consumers never suffer from things like systemic risk or--just say--RE prices driven up unsustainably by "unqualified buyer" bids, or any other adverse consequence of underpriced mortgage risk. However, number 2) is plausible only if the "harm" to the three or four people who cannot possibly verify repayment ability and yet still ought to get a residential mortgage loan is more likely to bring the economy to its knees than across-the-board prohibition on stated income lending would.

So what would constitute a "higher-priced mortgage"? The proposed threshold for first lien mortgages is an APR 3.00 points over the comparable Treasury security. According to the Fed, that should pick up all subprime and "the riskier end" of the Alt-A market. I remain unconvinced.

"APR" is not equal to the initial (or permanent) contract interest rate on a mortgage loan. It is an attempt to calculate the "true cost" of credit by taking into account points and fees paid up front (including mortgage insurance premiums, where required), as well as future changes in the contract rate (for ARMs). If you had a fixed rate loan with no fees or points charged, the APR would be equal to the contract rate. When there are fees and points, they are amortized over the contractual term of the loan and then added to the interest due. If the loan is an ARM, the APR is calculated by taking into account scheduled adjustments up to the fully-indexed rate (the highest rate possible given the current index value, which is assumed to be unchanged over the life of the loan). For a 30-year loan (of any kind), the comparable Treasury security is the 30-year Treasury bond.

At the moment, the national average rate for a 1-year ARM (no initial fixed period) according to Freddie Mac is 5.05% with 0.70 points. If you assume a standard prime margin of 2.75%, a one-year CMT index (currently 2.71%), a 1.00% origination fee plus another $1,500 in other fees (which is a lot) and a $100,000 loan amount, the APR on the "average" loan is 5.73%. The current yield on the long bond is in the neighborhood of 4.348, so this "average" loan is 1.382 over the comparable security, or well within the tolerance.

I could let you get away with stating income for an additional 100 bps in rate and margin and points (6.05% start rate, 3.75% margin, 1.70% total discount points). That would result in an APR of 6.85%, which is still comfortably within tolerance.

In fact, I could charge you 6.50% on the start rate, 400 bps on the margin, and a whopping 3.00 in discount (plus your 1.00% origination fee and $1,500 in other fees) and still be under the APR threshold (7.26%). I personally can imagine a lot of lender stupidity going on for that much "risk based pricing" (all justified, of course, by a sexy FICO score and a happy appraisal), none of which would get me into regulatory prohibitions. Does this additional yield actually compensate adquately for the amount of risk being taken here? The rating agencies, for one, seem to be telling us that it doesn't.

The trouble here is that the Fed wants some way to quantify "problematic loans," but since it doesn't want to make hard-and-fast rules about prohibited or allowable loan terms, it proxies the matter by pricing. In other words, it takes a certain "historical" correlation between loan risk and APR, declares that APRs of a certain level are "higher-priced," and then prohibits some risk-layering on those loans. This is the model that HOEPA has used since the mid-90s. The idea is supposed to be that competitive forces in the marketplace will prevent any lender from charging the highest fees and points to loans that don't have these risk factors. Loans that do have a lot of risk factors eventually bump up into this price ceiling at which--theoretically--we are no longer just pricing actual risk competitively but overpricing. The result, again in theory, is that lenders won't make certain extremely high-risk loans, because they cannot "price" such a risk without hitting the threshold that requires less risk in the loan. (You could not, for instance, "price" stated income at 3.01% over the 30-year bond. Once the APR on the loan is that high, stated income isn't allowed.)

But nobody is pricing or has ever priced stated income anything near like that in Alt-A. The whole idea of "Alt-A" is that the borrowers get "near prime" rates and points; the ability to do that was always a function of pricing logic that "paid up" for higher FICOs and lower LTVs based on sunny appraisals and sunnier assumptions about home price appreciation. We may not be in that kind of crazy pricing land now, at the moment, but there's nothing here that would stop us from going there again if memories are as short in this regard as they have proven to be in the past.

I might not be quite so cynical about the pricing of stated income loans had I not just read this:

One Oakland woman, who asked not to be identified, explained how she exaggerated her income - with encouragement from her mortgage broker - when she refinanced her home.

"He didn't say anything illegal out loud," she said. "He didn't say 'lie,' he just made a strong suggestion. He said, 'If you made $60,000, we could get you into the lowest interest level of this loan; did you make that much?' I said, 'Um, yes, about that much.' He went clickety clack on his computer and said, 'Are you sure you don't remember any more income, like alimony or consultancies, because if you made $80,000, we could get you into a better loan with a lower interest rate and no prepayment penalty.' It was such a big differential that I felt like I had to lie, I'm lying already so what the heck. I said, 'Come to think of it, you're right, I did have another job that I forgot about.' "

This is your helpful mortgage broker, working tirelessly to get the lowest rate and points for his customers. Of course that's rather a perverse approach to loan pricing--go stated income so your DTI is lower so you can get a better rate--but the proposed regulation won't do anything to fix it that I can see.

Really, this is all more of the weirdness you get when you buy into the "it's a subprime thing" thing. You really do have to believe that the problem is primarily interest-rate related (borrowers are defaulting because they cannot afford their rate resets or payment recasts), not house price-related (borrowers can't afford their houses at just about any rate).

by Calculated Risk on 2/04/2008 03:53:00 PM

This adds to Fed's loan survey (previous post) showing tighter lending standards and falling demand for commercial real estate (CRE).

MBA Reports Commercial/Multifamily Originations Down in Q4

Commercial and multifamily mortgage bankers' loan originations fell on a year-over-year basis in the fourth quarter, according to the Mortgage Bankers Association’s (MBA) Quarterly Survey of Commercial/Multifamily Mortgage Bankers Originations. Fourth quarter originations were sixteen percent lower than during the same period last year. The year-over-year decrease was seen across most property types and investor groups.
...
The decrease in commercial/multifamily lending activity during the fourth quarter was driven by decreases in originations for most property types. When compared to the fourth quarter of 2006, the overall decrease included a 73 percent decrease in loans for office properties, a 50 percent decrease in loans for industrial properties, an 38 percent decrease in loans for retail properties, an 7 percent decrease in loans for multifamily properties, as well as a 349 percent increase in loans for hotel properties and a 3 percent increase in loans for health care properties. The increase in hotel originations was heavily influenced by large portfolio sales during the period.