Housing Improvement And Repurchase Clarity Good For Banks

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 |  Includes: BAC, C, FMCC, FNMA, PNC
by: David Sims

Based on the fact that Bank of America (NYSE:BAC) and Citigroup (NYSE:C) are trading well below their stated book value per share, a reasonable investor would expect that there are some unrecorded liabilities threatening results. However, investors have some reasons to be optimistic.

Repurchase Reserves Reasonable

One of the biggest questions for the corporate accountants centers around mortgage repurchase reserves. In the past few quarters, additions to these loss reserves have been hard to quantify for a number of reasons. Home prices were declining and Fannie Mae (OTCQB:FNMA) and Freddie Mac (OTCQB:FMCC) stepped up their efforts to push bad mortgages back to banks that created them.

Investors can breathe a sigh of relief, however, as the FHFA has recently given Bank of America and other banks guidance on the amount of future repurchase requests and the underlying data driving these requests from Fannie Mae and Freddie Mac. Over the past few years, the agencies have requested about $80 billion in total repurchases from banks across the sector and the banks have resisted feverishly. The FHFA is concerned that additional requests are threatening availability of mortgage loans.

As a result, PNC Financial Services Group (NYSE:PNC) booked $350 million in losses associated with these claims, as it received updated guidance from Freddie Mac. The market perceived this news well because it quantified the potential negative impacts of repurchases. The FHFA is aware that quantifying the expected losses is good for the banks supplying the loans and gives them more confidence to increase lending in the market.

More Good News -- Home Prices Rising

Recent reports on home prices show that the market is improving steadily. The Case-Shiller 20-city Index rose 1.3% from March to April. Only one city out of 20, Detroit, showed a decrease in home prices for the period. Phoenix, Ariz., one of the hardest hit areas during the implosion of the housing bubble, showed an 8.4% increase in home prices vs. the same period in the prior year. This improvement in home prices should drive improved results in loss reserves surrounding mortgages.

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Housing Inventory Declining

The increases in home prices are likely due to reductions in overall home inventory. Even at reduced sales volume, inventory levels are at 6.6 months supply. If sales continue to increase, supply will continue to fall. The National Association of Realtors is actually saying that reduced existing home sales levels from April were the result of supply constraints. Continued tightness in inventory will drive further price increases.

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New-Home Sales Getting a Boost

New-home sales for May got a boost from reduced inventory levels. Seasonally adjusted sales were 369,000 vs. 350,000 expected by analysts. This marks a 19.8% gain over May 2011 sales of 308,000. Building permits were also reported to be 780,000 several weeks ago, with analysts expecting only 725,000.

Lennar Corporation (NYSE:LEN) reported today that orders for new homes are up 40% and the backlog of orders is up 61%. It also reported that sales margins and the average sales price was rising. As homebuilders begin to increase their backlogs, they will increase prices. This will also drive expansion in hiring. It is unlikely that the industry will be able to ramp up production to meet mounting demand within the next few months, which means that supply will continue to be tight in the future.

Existing Home Sales Improving

Today, the National Association of Realtors reported that pending home sales rose 5.9% to 101.1 for the month of May. In comparison with the prior year, sales rose 13.3%. Analysts expected a 0.5% increase for the month. The improvement in existing home sales will help to absorb the excess inventory of homes that may exist as foreclosures.

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Extension of Operation Twist

The extension of Operation Twist will drive higher numbers of refinances and home purchases. It was recently reported that refinancing under the HARP 2.0 program doubled from the fourth quarter of 2011 to the first quarter of 2012, from 93,000 to 180,000. As these mortgages are modified, new terms are set and they will have reduced chance of defaulting or being pushed back.

All that remains is a defined plan for housing finance, which the Obama Administration promised to deliver this spring. For time being, interested parties will have to rely on hopes and rumors.

Disclosure: I am long OTCQB:FNMA, OTCQB:FMCC. Holdings include FMCKI, FMCKP, FMCCO, FMCKJ, FMCKK, FNMAL, FNMAO, FMCCL, FMCCS, FMCCP, FMCCT and FMCCK.