Financials: No Sign Of Let Up From Subprime [Housing Tracker]

Subprime Banking Fallout

Tokyo Mitsubishi Joins Queue Of Suitors For Lehman Brothers. “Japan's biggest bank is poised to enter the bidding for a stake in Lehman Brothers (LEH) and may seek control of the ailing Wall Street titan. Senior sources close to Tokyo Mitsubishi say that the possible acquisition is being treated as a “once in a lifetime” opportunity but that the notoriously conservative bank would proceed with caution. Tokyo Mitsubishi, which has ample sources of funding for a multibillion-dollar acquisition, is expected to keep its powder dry until after Lehman announces its third-quarter results next week.”  (Times Online, Sept. 4) 

Investments Are Faltering in Chrysler and GMAC. “Cerberus Capital Management, is racing to salvage multibillion-dollar investments in… GMAC, the financing arm of General Motors (GM)… GMAC, in which Cerberus holds a 51% stake… GMAC and its home loan unit, Residential Capital, announced that they would dismiss 5,000 employees, or 60% of the unit’s staff, and close all 200 of its retail mortgage branches… This summer, Residential Capital and its bondholders restructured $14 billion in bonds to ease its debt burden. That restructuring and new loans from GMAC… may not be enough to save the firm from rising defaults on mortgages. Residential Capital bonds are trading at about 70 cents on the dollar.” (NY Times, Sept. 3) 

2 Ex-Credit Suisse Brokers Charged In Bln-Dlr Subprime Fraud. “Two former Credit Suisse (CS) brokers were indicted on fraud charges Wednesday for selling one billion dollars in subprime-related securities disguised as safer investments, officials said. The Justice Department [is] charging Julian Tzolov and Eric Butler, former brokers at Credit Suisse Securities, with conspiracy, securities fraud, and wire fraud. The indictment alleges that Tzolov and Butler "schemed to obtain higher sales commissions" by selling auction rate securities disguised as safer bonds backed by student loans. FBI: "Investors who were told they were purchasing relatively low-risk securities backed by student loans were unwittingly purchasing high-risk mortgage-backed securities.” (AFP, Sept. 2)

D.E. Shaw Jumps into ABS Trading. “D.E. Shaw & Co., a subsidiary of $39 billion investment firm the D.E. Shaw group [has] formed an asset-backed securities unit; lead [by] Richard McKinney, former head of securitized products at Lehman Brothers Holdings Inc.  McKinney departed Lehman last month, and is part of a growing stream of Lehman traders heading elsewhere… Merrill Lynch & Co. (MER) announced its own new hires in the MBS/ABS arena; it’s clear that more than a few Wall Street and investment heavyweights are positioning to trade in the rubble of the private-party secondary mortgage market, as well as to bolster their presence in the agency MBS market.” (Housing Wire, Sept. 2)

Fannie, Freddie See Preferred Shares Cut by Fitch. “Fitch Ratings became the last of the three major rating agencies to drop its ratings on the preferred shares on both Fannie Mae (FNM) and Freddie Mac (FRE)… Moody’s Investors Service and Standard & Poor’s Ratings Services did the same late last month. Fitch cut its ratings on preferred shares at both mortgage finance giants to one notch above junk, at BBB-, citing a lack of financial flexibility: “While Fitch believes capital at both firms remains adequate for the intermediate term, the capital markets have significantly discounted the value of both common and preferred stocks, effectively limiting any potential issuance from either GSE.” (Housing Wire, Sept. 2)

FDIC Chief Is Facing Exceptional Challenges. “Sheila Bair, the chairwoman of the Federal Deposit Insurance Corp., warned last week that the outlook for the ailing banking industry was bad - and getting worse. Bair: ''We haven't seen the trough of the credit cycle yet.'' FDIC's latest quarterly assessment of the industry [showed] the number of bad loans at banks ballooned to its highest level in 15 years during Q2. Industrywide, bank earnings plunged 86% from April-June, to $4.96 billion, from $36.8B a year earlier. The FDIC… also raised the number of banks on its list of problem lenders [with] combined assets of about $78B.” (NY Times via Salt Lake Tribune, Aug. 31)

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Comments

[Be Advised:]

I am not so sure. I have been trying to find an entry level condo in southern California. Most of the inventory is bank owned. They are not listed for pennies on the dollar as some predicted. Most of the available homes have multiple offers pending and many are now selling for for more than the list price.

A clear bottom in the housing correction would do a lot to remove the fear of investing in mortgage bonds, which could lower rates, which could bolster the market, which could prevent more homeowners from going upside down, which could stem the tide of foreclosures, which could help the keep the subprime mess from spreading to conventional loans. That would be good wouldn't it?

2008 Sep 08 02:39 PM

[SA Editor J...:]

Yours is the question of the hour really. Homebuilders, financials, bloggers, buyers and sellers and even ratings agencies debate this issue vigorously and constantly. If people are bidding on condos even though they are not at rock bottom prices as you say, then is it the bottom?

Obviously, I don't know the answer to that question. But here are just two things to think about in trying to.

One is that many billions of dollars more worth of ARM mortgages and other exotica between subprime and prime mortgages are still in the process of resetting. I don't have the numbers in front of me, but I recently read that dozens of billions will be resetting in the next month and a half alone. Maybe with Fannie and Freddie's new look, banks will start lending, mortgages will now become more affordable and people can refinance in to a good, solid mortgage at a decent rate. After all, the Fed Funds Rate stands at 2%! People should be able to get a better deal than the 6-7%+ lenders are offering. But so far they can't and lenders won't lend even the sturdiest buyers for low rates right now. Risks are too high.

Even if we're at the bottom, the market is still, well, at the bottom. Those that cannot afford the 10%-20%-even 40%-50% mortgage payment hikes, and cannot refinance or are not eligible to refinance, will not be able to sell. If they do, it will be without equity or even negative equity. Many will likely walk away. That's a lot of product coming on to the market. I won't even touch on the trend of rising prime mortgage delinquencies, the scenarios become even uglier.

The other issue is why this whole thing started. Affordability. A bubble was created by prices just inflating and inflating and inflating until most people simply could not afford to buy anymore-- particularly in SoCal, as I'm sure you know.

If sales are rising, is it because people can finally afford to buy houses now? Have prices reverted to the affordable mean already?

[There's an actual measurement for that, by the way. Housing and Urban Development has an affordability metric, if I'm not mistaken. i.e. how much of their salaries can spend on housing and still live above the poverty line.]

Obviously, I don't know the answer to that question either. But I personally believe that the answer to it will define the real bottom to this whole thing. If most people still can't afford to buy homes for a reasonable part of their salary, then the downturn will only stop when they can.

Having said all that, I hope you're hopefulness turns out to be well-placed!

ATB,
Judy

2008 Sep 08 04:22 PM

[billddrummer:]

Hi Judy,

A well-conceived post. Another way to look at how the bubble was created and sustained is that the exotic mortgage products that were available (layered risk, not necessarily subprime) were primarily responsible for unlinking income from mortgage affordability. In some cases, homebuyers would get a conforming loan (80% LTV) with a pick-a-payment option that allowed them to pay a 1% interest rate on a 6% note. Then, the homeowner would obtain a second mortgage for 15% of the value of the property, with an interest-only payment for, say, 5 years. Now you have 95% financing on a home, but the owner is only paying 1% interest on the first mortgage, and no principal on the second. It's easy to afford those payments--in fact, they were lower than many people were paying for rent.

With the secondary market in full swing, those loans carried big premiums when sliced into tranches and sold. Especially if the borrower had a good credit score. Many mortgage companies didn't bother looking at whether the borrower could afford the 'normal' payments, and debt ratios on 1% money were really low. Tranches created from low DTI and high credit score pools carried the highest premiums. (I worked for a small mortgage company that specialized in those kinds of loans.)

As a consequence, more and more buyers flooded the market, bidding prices higher. Builders responded by ramping up production, and the race was on. Meanwhile, existing homeowners found that if they didn't move but refinanced, they could buy the flat panel they always wanted with their new-found wealth. And boats, vacations, RVs and all the other extraneous goodies that make living in America so much fun.

When defaults started to happen with the lower credit score loans, and everyone thought the problem was contained within that sector, a funny thing happened: Mortgage companies started to tighten their qualifying criteria (this was in early 2007). As a result, the pick-a-pay option became less available, until it all but disappeared by the end of 2007.

Now, with home values falling but mortgage balances rising (as you pointed out elsewhere), those people who got 95% financing are finding that they are actually 110% or higher financed. Whether they will walk away is anyone's guess. But the first mortgage holder on option ARMs has a club: When the deferred interest balance rises to 110-125% of the original loan balance, a new amortization schedule takes effect on the full amount, but over the remaining term. Which could mean a doubling of your monthly payment. Look for lots of defaults when that starts to happen, because these people can't afford the new payment, have to pay cash at closing to sell their house, and can't refinance out of the loan because there's no more equity. (Some lenders were making 125% loans back in 2005. Most of them are gone now.)

The second mortgage holder in the scenario I described is left out in the cold. So banks that specialized in piggyback seconds are now at risk for total losses on them if the homeowner defaults on the first.

This period is unprecendented in the real estate industry, and I'm waiting to see what happens next.

2008 Sep 12 08:05 PM